In an effort to cool off the white-hot real estate market in Sweden, the country’s Financial Supervisory Authority (FSA) has been given permission to require homeowners to pay down the principal on their mortgages.
The basic idea here is that the more you have to pay each month on your mortgage, the less you can afford. And if prospective buyers can afford less, home prices must come down. At least, that’s the hope.
Mortgages that feature exotic characteristics such as interest-only periods allow borrowers to purchase more house than they normally would because no principal in due for the first 10 years on a 30-year mortgage.
Instead, the entire payment goes toward interest, which makes the loan more affordable but doesn’t actually require the homeowner to pay down their mortgage.
Unfortunately, this means the only way a homeowner can gain equity is via home price appreciation, which is particularly dangerous if home prices are already inflated and at risk of falling.
That scenario actually played out here in the United States during the recent housing bubble, though it was even worse because of the prevalence of option arms, those that allow negative amortization.
Both interest-only loans and negative amortization loans have been all but banned thanks to the Qualified Mortgage rule that doesn’t allow such features.
Most loans now meet the QM rule meaning only specialized non-QM lenders offer things like IO. I’ve yet to see any banks offering negative amortization again.
70% of Swedes Have Interest-Only Loans
In Sweden, roughly 70% of homeowners have interest-only mortgages, meaning disaster is imminent if the real estate market follows the fateful path ours did just a few years back.
The new rule wouldn’t go into effect until next May, and would exempt mortgages to purchase newly built homes.
Apparently most banks and lenders in Sweden already require borrowers to pay some portion of principal each month, but this rule would make it mandatory.
The Swedish FSA recommends that home buyers pay at least two percent of the principal balance each year until the loan-to-value ratio falls to 70%.
After that, they believe homeowners should pay at least one percent of the principal balance until the LTV drops to 50%.
Here in the United States, interest-only is mainly a thing of the past but 30-year fixed mortgages continue to be the loan of choice for most home buyers, especially first-timers.
For example, a $200,000 30-year fixed set at 4% would only pay down about $3,500 in principal in year one, or less than 1.8% of the total balance.
That fails to meet the recommendation of the Swedish FSA. Also consider that homeowners in the U.S. put very little down, sometimes just 3% or 3.5%, making the loans very risky if property values take a dive again.
I certainly believe homeowners should have a choice as to whether they want to pay down their loans or invest elsewhere, but they absolutely must be qualified to do so.
Consider a 15-year fixed instead. That same $200,000 loan amount set at 3.25% (lower because it’s a 15-year mortgage) would pay off more than five percent of the principal balance in year one.
Of course, many borrowers can’t afford the payments on a 15-year fixed, which is why the 30-year remains so popular. It may also be one of the reasons home prices are so high…