The Dutch mortgage market has attracted much interest in recent years by new investors, also outside of the Netherlands. For example, many pension funds and insurance companies have increased their allocations to Dutch mortgages, due to the high and stable spread, low risk profile and limited capital requirements. In this article, we give a global overview of the characteristics of the Dutch mortgage market. We also provide more insight in the impact of the ongoing coronavirus crisis on this asset class.
The Dutch mortgage market
The outstanding market size of Dutch mortgage debt is about €725 billion; the annual volume is around €100 billion. The fixed-rate term of a mortgage can be up to 30 years. Banks focus mostly on mortgages with a fixed term of up to 10 years, whereas insurance companies and pension funds focus on mortgages with a longer fixed-rate term. Most mortgage lenders allow a prepayment of 10% of the loan per year without a penalty.
Predominantly prime, owner-occupied mortgages are sold. There are virtually no buy-to-let, non-conforming or sub-prime mortgages. The Dutch mortgage industry applies "full-doc" underwriting and does not allow self-certification of income. There is an industry-wide credit database (BKR) and Fraud Register (SFH).
Lenders also have a strong legal position: there is full recourse to the borrower. In case of default, lenders can repossess and sell properties by public auction without a court order. Further recourse is available to other wealth, including salary. Any remaining debt remains enforceable until discharged in full. Moody's (2013) ranks the Netherlands high in terms of the legal right of recourse and in the practice of enforcement in comparison to other countries.
The Netherlands traditionally has a generous tax regime for homeowners. Interest paid on mortgage loans is deductible from pre-tax income (for at most 30 years). For incomes up to € 68,507 (before tax deductions), the interest paid is fully deductible. For higher incomes, the tax deductibility is decreasing in the coming years. As of 2013, new mortgages need to be an annuity or linear mortgage to be tax deductible. Existing interest-only mortgages are grandfathered and will remain tax-deductible.
Mortgage loans are provided predominantly on the basis of income. The legally-binding code of conduct sets the maximum loan-to-value (LTV) and debt-to-income ratio. LTVs are less of an issue in the Netherlands due to tax incentives that make Dutch mortgages much more affordable than in other countries. The average LTV at origination has come down from 96% in 2010 to 89% in 2013 and has been stable since. The average debt service-to-income ratio of the mortgages in the Netherlands is around 15-20%.
NHG mortgage guarantee scheme
The NHG program is the public mortgage loan guarantee scheme supporting home ownership in the Netherlands. An NHG guarantee can be obtained for an amortizing mortgage loan up to an amount of €310,000. The mortgage lender receives 90% compensation from the NHG program in case of a loss on an NHG mortgage. The borrower pays a one-off fee of 0.7%. This is compensated by lower interest rate payments due to the government backup of NHG loans.
Dutch households have a good track record in paying off their debts. Fitch (2013) ranks default probability for Dutch mortgages among the lowest in Europe. This is due to employment protection and strong unemployment benefits, strict underwriting rules and the strong legal position of lenders. This contributes to historically low losses on Dutch mortgage portfolios.
Mortgage arrears are relatively low for the Dutch market (only 0.2% has arrears of three months or more), see Figure 1.1 In most other European countries the arrears vary between 0.2% and 3.3%. France, UK and Belgium are at the lower end, Portugal, Spain, Italy and Ireland are at the upper end. An outlier is Ireland, with an arrears percentage of 10.5%. This high percentage is partly caused by an extremely low foreclosure rate in Ireland, which leads to a low incentive to meet mortgage obligations. The typical duration of a mortgage foreclosure period is relatively low in the Netherlands (approximately half a year).
Figure 1: European mortgage arrears. Source: European DataWarehouse (as of February, 2018).
Figure 2: European mortgage defaults. Source: European DataWarehouse (as of February, 2018).
A similar picture emerges if we look at the mortgage defaults in Figure 2. Defaults are again very low for the Dutch market: only 0.07%. Most other European countries are in the range of 0.1% to 4.7%, again with France, UK and Belgium at the lower end, and Portugal, Spain, Italy and Ireland at the upper end.
In the Netherlands, the mortgage rate is relatively high when compared to the larger euro-denominated mortgage markets. Factors that may explain this are the relatively high loan-to-value of Dutch mortgages, the free option to (typically) prepay 10% of the mortgage per year and the relatively long maturity of Dutch mortgages.
Overall, mortgage rates have declined significantly after the financial crisis, in line with the general decrease of market interest rates. The spread over the euro swap rate has increased, however, after the crisis and is currently circa 2.1% for Dutch mortgages without an NHG guarantee, see Figure 3. For NHG mortgages the current spread is circa 1.7%.
Figure 3: Spread over the euro swap rate, with and without an NHG guarantee. Source: Bloomberg, Aegon Asset Management (as of April, 2020).
For liability-driven investors like pension funds or insurers, who base the valuation of their liabilities on the swap rate, Dutch mortgages thus remain an attractive investment opportunity. Dutch mortgages have, so far, also performed very stably during the coronavirus crisis. For example, our Dutch mortgage strategy had a return of circa +0.77% from January through April 2020.
Impact of the coronavirus crisis on mortgage rates
Dutch mortgage rates have been increasing since halfway March; Aegon also increased its mortgage rates by 20-30 basis points. This move can mostly be attributed to rising interest rates. Also for the coming period we expect that interest rate moves will be the largest driver of mortgage rates. Credit losses in mortgages are generally expected to be low, so a large spread widening is unlikely in our view. We expect the spread on Dutch mortgages to be range-bound between 150-200 basis points over swaps (195 basis points at the end of April).
Special measures due to the coronavirus crisis
Despite all government efforts to mitigate financial risks, mortgage borrowers may end up in financial difficulty. Some lenders are therefore offering blanket payment holidays. Aegon's policy is to assess the situation on a case-by-case basis to deliver tailor-made solutions (which has always been the case before the corona era). For borrowers with a stable income, a payment holiday may not be granted. However, borrowers experiencing a severe loss of income may be eligible to receive a payment holiday. In addition, forced sales will not be pursued until 1 July by Aegon, in line with the policy of other mortgage lenders in The Netherlands. This period could be extended, depending on market circumstances.
Impact on arrears and defaults
Arrears are expected to increase over the next few months. Depending on the impact of the lock down, they may increase to between 0.5% and 1.5%. Although in a worst-case scenario defaults could potentially reach 2014 levels, losses in the fund are expected to be limited to 13 basis points in an extreme case of a 30% fall in house prices and an assumed 1% and 10% default rate for employed and self-employed borrower, respectively..
Impact on Dutch housing market
Mortgage production levels are expected to be lower from June onwards. We expect less first time buyers, and fewer buyers with less stable income. This might also result in lower loan-to-values in the new production. We also expect fewer mortgages with a bridge loan component. House prices are expected to decrease, but we do not expect house price declines as seen between 2008 and 2013.
N.B. The information above is based on estimates and assumptions made by Aegon as a mortgage lender and Aegon Asset Management as the manager of the fund. Actual outcomes may differ from these expectations.
In this article, we provide an overview of the Dutch mortgage market. This market is large in size and is heavily regulated with respect to origination criteria. Historically, arrears and defaults have been limited, with efficient foreclosure procedures in place if needed. Additional risk mitigation is possible through the NHG guarantee scheme, which covers 90% of the losses in case an NHG mortgage defaults.
Spreads on Dutch mortgages are relatively high and stable, with the current spread level circa 1.9% above the euro swap curve. Dutch mortgage loans have held up well so far during the recent coronavirus crisis and investors have enjoyed the stable nature of this investment. The economic consequences will of course also have an impact on the mortgage market. However, we expect a moderate effect on mortgage rates and defaults going forward.
1 These data relate to the underlying mortgage pools of residential mortgage-backed securities.