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You cannot live in a mortgage



A reduction of the loan-to-value (LTV) will have far-reaching consequences for the housing market. Potential house buyers - particularly first-time buyers - will have to increase their savings before being able to buy a house. As a result they will be more likely to put it off or live in rented accommodation instead. However, owing to the static nature of social housing and the tightness of the private rental market, rental accommodation currently falls short of being a good alternative to the purchased housing market with its relatively high mortgages and poor accessibility. The nature of the property market means it will take years for this scenario to change. A reduction of LTV would be welcome in the long term, but reducing it too rapidly will squeeze households excessively. And that will be bad news for the housing market.

Consensus about lower LTV, details unclear

In its report Towards a serviceable and stable banking system (June 2013), the Wijffels commission presented various recommendations for the financial sector. One recommendation related directly to the housing market is the proposed reduction of LTV to 80%. One effect of this would be to reduce the debt exposure of consumers in future, by lowering the risk of negative equity. Secondly, the deposit funding gap would be reduced thanks to a lower financing requirement and possibly larger savings. Moreover, in the long term the financing costs of banks would be reduced, ultimately leading to lower mortgage interest rates. Meanwhile, in the cabinet's report on the Dutch banking sector (August 2013) the government has endorsed the Wijffels recommendation. Government plans already allow for a reduction of LTV from 105% in 2013 to 100% by 2018 (Government publication, 2012). However, the perspective for the future remains unclear. According to this publication, if the housing market should recover strongly, further proposals will be made regarding the ultimate LTV ratio and the further path towards reducing it after 2018. In other words, it is unknown what decisions will be made after this period.

In our recent outlook report Living Differently (Piljic en Stegeman, 2013) we likewise expressed our view that it makes sense for the LTV to be lowered in the long term. However, this is not so much from the perspective of financial stability, but it will arise from a shift in consumers' housing preferences. The changes made relating to the housing market this year will ultimately lead to a more balanced co-existence of rental market and property market and the reduced tax deductibility of mortgage interest will make it less attractive to service a debt. Over time, this will automatically result in a reduction of LTV, without any outside interference.

Where does the risk lie - LTV or LTI?

In the Netherlands, the maximum mortgage is determined on the basis of income, mortgage interest rate and mortgage borrower's age according to the guidelines of NIBUD - the National Institute for Family Finance Information (NVB, 2013). These mortgage lending standards and the new mortgage requirements were again adjusted downward in 2013 as a result of the declining purchasing power (Nibud, 2013). The mortgage lending standard is also known as the mortgage-to-gross-income ratio. This ratio reflects the balance between spending on housing and disposable income. The Code of Conduct for Mortgage Financing explicitly states that this financing standard is in principle binding, and that mortgage banks may not apply their own front-end ratio in any way whatever. The ratio of mortgage to income is internationally known as loan-to-income ratio (LTI). This method of dealing with mortgage lending differs from what is customary in many other countries, where the focus is more on LTV and less on LTI. Thanks to the strict application of the mortgage lending standards - particularly in recent years - mortgage arrears in the Netherlands are relatively low compared to many other countries, despite the high LTV.

Figure 1: High LTV most prevalent among younger home-owners
Figure 1: High LTV most prevalent among younger home-owners
Source: CBS 

This is not to say that there are no risks attached to a high LTV. An LTV above 100% implies that there will be residual debt. This applies in particular to those who purchased a house in recent years - most of whom are younger home-owners (Figure 1). However, as long as they don't have to sell their house, there is no problem. Nonetheless, negative equity remains an impediment to moving on, which may be a problem for those who are forced to sell, for instance as a result of divorce or losing their job. In the long term, therefore, a lower LTV reduces the financial vulnerability of families, but also improves the functioning of the housing market.

International comparison: the whole story

In the discussion about a lower LTV in the Netherlands, reference is often made to the situation in Germany or Denmark. However, a comparison of debt financing on the housing market cannot be separated from the institutional context.

Figure 2 shows the mobility in both the rental and purchase sectors in a number of European countries. It is clear that mobility in the rental sector is greater than in the purchase sector in all countries. This stands to reason: the costs involved in buying a home are greater than those for renting - even apart from the acquisition and financing costs. It is also noticeable that mobility on the Dutch rental market is considerably lower than in countries where a lower LTV is applied, such as Germany, Denmark or the U.K. This can be partly attributed to the long waiting lists in the Dutch social rental housing sector (Beetsma, 2012) as well as the - by international standards - very small private rental sector.

Figure 2: Mobility in the purchase and rental sector
Figure 2: Mobility in the purchase and rental sectorSource: Van Ommeren (2006), based on ECHP 1990-2000
Figure 3: Composition of Dutch housing stock
Figure 3: Composition of Dutch housing stockSource: CBS

Clearly, the private rental sector in the Netherlands is an underdeveloped alternative. The reason is that on both the supply and the demand side, it was hitherto not attractive to be active in this segment. On the demand side, preference was given either to the social rental sector (low rents, good housing quality, albeit with long waiting lists), or the purchase sector (which often offered lower monthly financing costs than private rented property, thanks to the tax relief on mortgage interest). On the supply side, the private rental market was often not cost-effective for suppliers or investors, because of the difficulty of competing with both the social rental sector and the private property sector. Gradually, change is occurring in this situation, designed to reduce this anomaly. Efforts are being made to ensure that social rental housing is allocated more fairly, higher rent increases in the social rental sector are being permitted, and mortgage fiscal deductibility has been reduced.

The housing supply is only one part of the entire picture. The financing side also plays an important role in establishing the level of LTV. And it is not always clear what the situation is now or what it was before, in terms of supply, financing structure or housing preferences. Box 1 shows that Germany has a very different housing market system than the Netherlands, with considerably less home ownership. Equally, the so-called Danish model of mortgage lending, with a maximum LTV of 80%, is not automatically applicable to the Dutch situation (Piljic and Stegeman, 2011). The underlying structure of mortgage backed bonds incurred considerable losses during the crisis, when the collateral declined in value. At the same time, the maximum 80% LTV of banks is not watertight: buyers can borrow additional amounts from other lenders to pay for a house (Piljic, 2012). This is accompanied by higher interest rates and greater risks. In the Netherlands, consumer loans for the purpose of buying a house are not possible. The Code of Conduct for Mortgage Financing explicitly states that consumer credit and other household costs must be taken into account when establishing the amount of the mortgage.

With a maximum LTV of 105% [1] at origination, the Netherlands so far has had relatively few repayment problems. In other countries, such as the US (Dröes, 2011) Denmark and Canada (SER, 2013), the emphasis is on maximum LTV, whereas in the Netherlands, the loan-to-income ratio is the primary benchmark. A maximum LTV of over 100% is unthinkable for many countries (Figure 4). In the US, a mortgage with an LTV of over 80% is seen as exceptionally risky (Dröes, 2011). Thus it would appear that different countries have made different choices in seeking the right balance between loan-to-income ratio and LTV. Excessive tightening of either standard can impede the process of buying a house. At the same time, when standards are too loose, this can increase the risk and lead to more payment arrears.

Figure 4: Average LTV upon house purchase, an international comparison
Figure 4: Average LTV upon house purchase, an international comparison
Source: ECB


[1] Prior to 2012 the LTV was 104% plus 6% stamp duty (transfer tax). The reduction of stamp duty to 2% has been made permanent. Moreover, the LTV is being reduced by 1% annually until 2018, with one of these increments already completed. 

Related discussion, unclear outcome

Besides the domestic discussion about the lower LTV, also a wider discussion is growing with respect to the LTV and the housing market. Basel III is possibly going to regulate that securitized mortgages can only have an average maximal LTV of 80% upon origination (BIS, 2013). The current level of their LTV is higher than 80%.[2] Further implications are unclear; it is yet unknown whether mortgages with a National Mortgage Guarantee (usually with a higher LTV) will be excluded from this regulation. Covered bonds are already restricted with a maximum LTV of 80% (ECB, 2008). The domestic discussion about the maximum LTV might therefore be put into a different light.

Box 1: The German housing market – A dynamic rental market makes a lower LTV possible for first-time buyers
A much-cited example of a housing market with a lower average LTV is Germany's. However, the adoption of the German model for financing property purchases requires a different structure in the rental market. In contrast to what is generally assumed, the lower LTV ratios are not brought about by regulation, but by the housing preferences of the population (the government does not set a maximum LTV for mortgages issued by banks: however the financing of homes by mortgage bonds is statutorily set a maximum LTV of 60%, which means higher LTVs incur higher financing costs).

A salient feature of the German housing market is the relatively low percentage (43%) of the purchase sector compared to the rental sector. Only 11% of the rental market is in the social housing sector; the remainder is privately owned. Most of the owners are private persons who buy a house and rent it out as a pension provision or a safe investment. The bulk of these investment properties are funded with private equity. The government facilitates this rental market by employing a strict policy of rent protection. Property leases are usually for an unspecified period, and tenants can generally only be put out of the house if they fail to comply with what has been agreed (e.g. in payment arrears), or if the lessor wishes to use the house himself. There are also rules attached to maximum rents (no higher than the average of new rents) and the annual permitted rent increase (no more than 20% in a three year period). Rents in new contracts may not rise above 50% above the average going rate in the locality. Thanks to these regulations, Germany has a relatively stable rental market, with reasonably priced rents, allowing new entrants to the housing market the time to save up to buy their own home.

In Germany, it is unusual to fully finance a home by taking out a mortgage. This is partly due to the well-functioning private rental sector, which means there is less rush to buy a house, and thus little demand for maximum mortgages. Furthermore, government policy does not actively promote home ownership, as there is no tax advantage to purchasing as opposed to renting a home. Debt financing is thus not encouraged. In addition, the credit lending policy of German banks is fairly conservative. One reason for this is that only the first 60% of the value of a house can be financed by mortgage bonds, with the house itself as collateral. In the case of a higher LTV, the bank has to fund the additional percentage from alternative sources (such as private equity), which leads to a sharp increase in financing costs. Accordingly, the residual amount is usually funded by a building society loan. To be eligible for such a loan, fixed monthly savings have to be first built up, after which an additional (subordinated) loan can be issued. Both the savings period and the loan period are characterised by relatively low interest rates. Because the building societies operate as small cooperatives, they cannot lend more than they have in savings - from other members. Consequently, it often takes up to a year after sufficient savings have been accumulated by an individual member for a loan to become available. Furthermore, the loan has to be repaid relatively quickly, by comparison with a standard mortgage, so that the next member can obtain credit. Owing to a combination of the above factors, the LTV for first-time buyers in Germany stands at 70%, compared to a European average of 79% (ECB, 2009). At the same time, the rate of home ownership is lower than in the Netherlands.


[2] This mortgage packages can be combined with (existing) mortgages with a lower LTV than 80%. In this way the average LTV of the package can be lowered.

A gradual reduction is the only option

A high LTV is therefore on the one hand more risky, but is also the result of the structure and institutions in place on the housing market. Consequently, any reduction to the LTV must be seen in the context of the entire housing market. A lower LTV for new mortgages will have far-reaching consequences if it is introduced rapidly. With an LTV of 80%, the purchase of an average house (€214,778, CBS, 2013) plus costs (average 6%, Kosten Koper, 2013) will require savings to the tune of € 55,000. For home-owners in negative equity, this is a considerable impediment to their mobility on the property ladder. And first-time buyers in particular, will have to save more. With starter homes costing an average of € 175.125 [3] plus costs, savings of over € 45,000 will be required. However, 78% of recently relocated first-time buyers had no capital in box 3 (Figure 5), and would have to save up for years.

Figure 5: Insufficient savings among recent first-time buyers
Figure 5: Insufficient savings among recent first-time buyers
Source: Own calculations on the basis of WoON2012; outliers filtered in line with Brosens (2009).

In order to build up savings, these first-time buyers would first have to live in rented accommodation, or remain with their parents for longer, or even in student housing. The rental alternative would of course be best: after all at the start of one's adult life, both work and private circumstances are subject to major change. It therefore makes sense for many to live in a more flexible way. However, this is where the roadblocks in the housing market are most evident: a static social rental market and tightness on the private rental market.


[3] Own calculations, based on WoON2012.

Main considerations and conclusions

The decline in house prices since 2008 has shown that, like other systems, the Dutch mortgage model is not immune to shocks. Despite the low level of payment arrears thanks to a primary focus on the loan-to-income ratio, a high LTV has led to negative equity and reduced mobility on the property ladder and in the housing market. It is important to learn a lesson from this. Indeed, the cabinet has already done so by taking steps to reduce LTV to 100% by 2018.

That said, further reduction of LTV - for example to 80%, as proposed by the Wijffels commission - should not be implemented over-hastily. That is also not happening in other countries. Banks are already issuing cheaper mortgages if buyers can put up some of their own money. That is among others caused by Basel III. The market is subsequently anticipating for the appropriate funding.

A rapid reduction of LTV will directly expose the other weakness of the Dutch housing market: the static nature of the social housing sector and tightness in the private rental sector. In view of the current nature of the housing stock, it will take years before this option has been developed properly. A too-rapid reduction of LTV would compel potential first-time buyers to live in accommodation unsuited to their income, or remain with their parents, or postpone buying a house. Moreover, existing homeowners would have to stay put for even longer, on account of residual debt.

At the same time, one might ask whether consumers themselves will not have already learned a lesson from the economic crisis. After all, you cannot live in a mortgage. It's about finding a house that meets the requirements of the house-seeker. In the Netherlands, there is a tendency to want to regulate everything. But a cultural shift on the housing market is probably more than enough to prevent people from repeating the mistakes of the past.


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Pieter van Dalen
Rabobank KEO
+31 30 21 2666
Hans Stegeman
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
Marcel Weernink
Rabobank KEO
+31 30 21 62666

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