Mortgage features that are restricted in the Dodd-Frank Bill such as longer terms, interest-only periods and flexible payment designs are quite common in other countries and are not associated with higher rates of default, according to a study released by the Mortgage Bankers Association (MBA). The study, "International Comparison of Mortgage Product Offerings," conducted by Dr. Michael Lea, director of the Corky McMillin Center for Real Estate at San Diego State University and sponsored by MBA's Research Institute for Housing America (RIHA), examines the predominant mortgage designs and characteristics that exist in different international markets and how they have performed prior to and during the crisis. The study examined 12 developed countries with distinctly different mortgage market and product configurations.
"The U.S. has traditionally had one of the richest sets of mortgage products available, offering a variety of adjustable rate mortgages, amortization choices and terms, along with long-term fixed-rate mortgages," said Dr. Lea. "As a result of the mortgage crisis, the market shifted to primarily fixed-rate mortgages, mainly driven by the historically low mortgage rates. As this shift is likely to remain under the guidelines of the Dodd-Frank Bill, it is important for those implementing the regulation to consider whether such a dramatic and permanent shift in the mortgage market will do more harm than good."
The study results showed that 95 percent of new loans made in the U.S. in 2009 were long-term fixed-rate products compared to various other countries with a lower share including one percent in Spain, two percent in Korea, 10 percent in Canada, 19 percent in the Netherlands and 22 percent in Japan. In addition, five percent of new loans made in the U.S. in 2009 were variable rate, which compares to the higher shares found in other countries including, 92 percent in Australia and Korea, 91 percent in Ireland, 47 percent in the U.K. and 38 percent in Japan.
"What are the desirable features in a mortgage instrument? There is no easy answer to this question as it depends on whether viewed from the borrower's or the lender/investor's perspective," said Dr. Lea. "Features attractive to borrowers may be costly or impossible for lenders to provide and in turn, features attractive to lenders may not be acceptable to borrowers. Though there is no perfect mortgage, the dominant instrument in any country represents a balance between borrower and lender/investor needs. Regulation may have an important influence if it bans or dictates certain features, and history too may play a role as an instrument that has been dominant in a market for a long period of time is familiar to both borrowers and lenders and may be difficult to dislodge."
"The U.S. housing market is not operating in a vacuum and therefore should not be assessed in one. This study aimed to examine how different mortgage products perform in various other countries to help better understand if the mortgage product designs themselves are flawed. By comparing the performance of mortgage products internationally, we see that many countries are experiencing lower default rates than the U.S., despite having a significant share of products such as adjustable rate mortgages and interest only loans. This indicates the problem with loan design in the U.S. during the crisis was one of a mismatch between borrowers and particular loan designs—not the existence of the loan features themselves. In addition, the lower default rates may reflect stricter enforcement of lender rights as all countries in the survey have recourse lending. By focusing regulation on loan product design, borrower choice will be deeply impacted as products that are commonplace in other countries will be considered "unqualified" for American borrowers," said Dr. Lea.
Key findings from the study include:
►Of the countries sampled, all typically subject fixed rate mortgages to an early repayment penalty except Denmark, Japan and the U.S. In Australia, Canada, Denmark, Germany, the Netherlands and Switzerland the penalties are designed to compensate the lender for lost interest over the remaining term of the fixed rate.
►While some believe that the fixed-rate mortgage (FRM) is the ideal consumer mortgage instrument for all borrowers, its use does have significant drawbacks. In effect, the cost of the pre-payment option is socialized, with everyone paying a premium in the mortgage rate for the option. This contrasts with the European view that only borrowers who exercise the option for financial advantage should pay the cost.
►The U.S. has an unusually high proportion of long-term FRMs as well as use of securitization in the finance of housing. The dominance of the FRM and securitization is driven in part by the presence of government-backed secondary mortgage market institutions that lower the relative price of this type of mortgage.
►The U.S. is unusual in the banning or restriction of prepayment penalties on FRMs. Most countries in the survey allow such penalties to compensate lenders for loss associated with the financing of mortgages. As a result, mortgage rates in those countries do not include a significant pre-payment option premium and other financing techniques, such as covered bonds, are more common.
►According to an EMF study on the efficiency of mortgage collateral, borrowers remain liable for deficiencies in Belgium, Germany, Greece, the Netherlands, Spain, France, Ireland, Portugal and the U.K.
"Today's borrowers range from the first time homebuyer, to the move up buyer, to the boomer contemplating retirement. We can't expect one mortgage product to fit all of their needs. A robust mortgage market is built on several different instruments that can be tailored to meet the varying needs of both borrowers and lenders," said Michael Fratantoni, MBA's vice president of research and economics. "Given the regulatory changes being implemented, MBA felt it was important to take a look at the range of product offerings available in other countries and identify potential features that could be used to safely expand market offerings in the U.S. As regulators begin implementing new guidelines for the mortgage market, we believe this information will help guide the changes to prevent future problems, while not restricting borrowers' choices."
To view the full report, "International Comparison of Mortgage Product Offerings," click here.
For more information, visit www.mortgagebankers.org.