The Danish mortgage model

by on September 26, 2009 at 5:01 pm in Economics | Permalink

The Danish model has another critical and innovative feature.  Holders can retire their own mortgages by purchasing the same face amount of mortgage bonds at the prevailing market price.  To prepay a mortgage by purchasing bonds, the home owner must give advance notice of several weeks to the MCI [mortgage credit institutions], which designates by lottery the specific bonds to be purchased.  Thus, if rising interest rates or other factors cause mortgage bonds to trade at a discount, home owners can reduce the principal or retire the whole mortgage by purchasing an appropriate mortgage bond at a discount.

That passage is from Robert Pozen's new and notable Too Big to Save? How to Fix the U.S. Financial System.

You can't do this in the United States.  You can pay off your mortgage but the "face value" of that transaction does not vary with market conditions.  In essence the Danish system creates a new contingent claims market for homeowners who do not understand how to use interest rate futures and options.  De facto, the homeowner receives some implicit insurance against the prospect of negative equity in the home.

Here is The Economist on the Danish model.  Denmark also allows for speedy repossession of property,  in case of default.  Here is a more general discussion of the Danish model, which emphasizes transparency.  Mortgage finance is conducted by explicitly designated institutions and originators retain a financial interest in the loan, even following securitization.  The emphasis is on plain vanilla products.  Here is Wikipedia on the Danish mortgage model.  Here is a longer study

Vernunft September 26, 2009 at 6:08 pm

If we could only trade what we have for 300 million Danes…

tomhynes September 26, 2009 at 7:46 pm

Per the link, Danish mortgages require 20% down. This, with the speedy repossession of property you mentioned mean risks are very low. Both are politically impossible in the US.

Aric September 26, 2009 at 10:44 pm

I’ve always wanted to pay off my mortgage by buying out the underlying bonds. I got 100% financing for my house in 2007, and given those facts, could probably have paid it off for 50% of face value late last year or early this year.

Vernunft September 26, 2009 at 11:45 pm

“And why should 20% down, once the norm in the US (as recently as when I bought my house in 1981), not become the norm again?”

How will we increase homeownership among discriminated-against groups with that kind of thinking?

:shakes head:

Alex Conconi September 27, 2009 at 4:17 am

The less down payment required, the more people can buy houses. The more homeownership at the end of your presidency, the more empowered a society you have left. The better job you’ve done. Prices of houses rise, those who already own, gain. Everyone wins. Right?

Bob Knaus September 27, 2009 at 6:35 am

MattM – don’t think of it as adverse selection, think of it as a bonus payment rewarding the individual for being a better credit risk than society as a whole.

Efficient markets theory suggests that arbitrage would soon make excess profits disappear as mortgage bond prices rose. In essence, the Danish system provides a negative feedback loop which stabilizes the market. Nice.

More broadly, I think economists would benefit from a semester of Electronics 101, the old-fashioned kind that used to be taught at vocational institutions. Having a mental map of resistors, capacitors, and transistors along with knowledge of positive and negative feedback would enlighten and simplify economist’s models of market behavior.

Carsten Valgreen September 27, 2009 at 9:58 am

Alan Boyce have been touring DC for about a year, to emphasize the point that the US can easily now introduce a “buy your debt back” option in the US system. George Soros wrote about it in the FT almost a year ago. This is simple to implement, as the GSEs are now effectually government owned. All it takes is a “total balance principle” forcing the GSEs to match all loans with securities with the same features. This neatly also reduces the balance sheet risk of the GSEs.

Read more here:

http://www.realkreditraadet.dk/Admin/Public/DWSDownload.aspx?File=%2FFiles%2FFiler%2FAarsmoede%2F2009%2FPrinciple_of_Balance_Lending_a_Better_Approach_Boyce_april09.pdf

Slocum September 27, 2009 at 11:40 am

Indeed, one might struggle to justify reasons why a binding defeasance might be preferable to a non-binding self-administered one.

One big problem is taxes. Your bond interest is taxable, and your mortgage interest payments are generally tax deductible, so they offset–but only if you earn enough to itemize but not enough to be hit by the AMT (at which point you’ll start losing the value of your mortgage interest deductions but still be paying your highest marginal tax rate on your bond interest. Ooops).

Simon Kinahan September 27, 2009 at 4:36 pm

Couldn’t you effectively achieve the same thing in the US market, at least through an intermediary, by buying up the bonds that make up your own mortgage, or failing that bonds with the same overall risk profile? You can’t formally redeem the mortgage, of course, but if the bonds are trading below par, you’d get back the interest part of your own mortgage payments, which would be worth more than the cost of the bonds.

mulp September 27, 2009 at 6:56 pm

The less down payment required, the more people can buy houses…. Right?

Wrong.

The higher the down payment, the lower the price must be and the market will meet the demand with lower priced houses.

Reducing to 10% down, increases the price of allowed purchases, reduces the amount at risk to the buyer, and shortens the time required to save the down payment. Going to 5% or lower is absurd.

The GSE low income programs not only reduced the down payment, but also reduced the interest rate in exchange for two things:
- borrower/buyer time demonstrating the ability to budget and save
- the lender retaining an equity interest in the property which will capture 100% of the subsidy on property sale
Those with low incomes have no interest in higher property prices.

Alex Conconi September 28, 2009 at 12:59 am

*maximum loan-to-value; ie: minimum down-payment

jk September 28, 2009 at 3:32 am

personal bankruptcy law is much different. It is not easy to walk away from debt in Denmark. There is also the welfare safety net that it makes it feasible to collect from people that have earnings shocks..

So it would seem that property rights are better protected in Denmark and that this might translate into attitudes about responsibility, etc.

Bob Smith September 29, 2009 at 4:59 pm

Foreclosure in Denmark may be speedy by European standards (years to foreclose in France!?), but the 6 months it takes is about average in the US. In most states it takes 4-6 months to foreclose.

Another thing is that with the mandatory fees and taxes, it’s actually rather expensive to buy and finance property in Denmark. 1.5 points just for legal fees? Yikes!

Aram February 24, 2011 at 9:10 am

You have an interesting article.I didn’t know about all this things.I was reading something about mortgage few days ago and I started to look for different possibilities because I want to get my own house.I found something interesting Florida reverse mortgage but still I am not certain of what I should choose.

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