New Measures to Regulate the Residential Mortgage Market Should Be Implemented with Caution

In order to prevent the residential real estate market from potentially overheating, German law-makers have created a number of what are known as “macroprudential tools” to be implemented in the mortgage market. If these new regulations are actually to be put into practice, however, this should be done with caution. Given the already far-reaching regulation of residential real estate financing and the fact that lending practices are already intended to encourage stability, this could run the risk of crossing the line into over-regulation. These measures could particularly inhibit home-ownership among German households with limited equity but a high regular income looking to buy relatively cheap housing.

These are the findings of a recent study conducted by the Centre for European Economic Research (ZEW), Mannheim, in collaboration with the Cologne Institute for Economic Research. The study analysed both macroeconomic data and micro data on the private household level, as well as previous instances of macroprudential measures that have been implemented outside of Germany.

In the event that the German residential real estate market is faced with the imminent threat of overheating in the future, the government will be able to set legal upper limits on individual loans in relation to the current market value of the real estate and/or minimum repayment requirements, for example by specifying a period of time during which at least a certain percentage of the loan has to be repaid. A law to this effect has been in force since early June 2017. Though the German government has emphasised that there is currently no imminent threat of the real estate market overheating, these newly created regulations can be activated at any time.

Macroprudential instruments have mixed results

The study conducted by ZEW and the Cologne Institute for Economic Research shows that macroprudential instruments have been implemented with mixed results in other countries. Placing legal limits on maximum loan amount in relation to real estate value can serve as a relatively accurate instrument since it has been observed to effectively restrict growth in the amount of mortgages issued during economic boom periods. In Germany, however, the relationship between credit growth and changes in house prices is rather weak. This could mean that the overall effect of implementing macroprudential instruments in Germany would be smaller. On the micro level, the German residential real estate financing market is also fairly conservative; due to pre-existing regulations most home buyers already have to put in a lot of equity and make regular repayments. Due to prevailing long-term fixed interest rates it is also unlikely that rising market interest rates would lead to a high number of loan defaults in the short term, as was the case during the US mortgage crisis for example.

Nevertheless, implementing macroprudential instruments, in particular restricting the maximum loan-to-value ratio, would have significant consequences for German households. According to representative micro data, 20 per cent of German home buyers who finance their real estate purchase through a mortgage, choose a loan-to-value ratio of over 90 per cent. These households are, however, usually subject to low debt-service costs relative to their income, and also tend to purchase relatively cheap real estate. Capping the loan-to-value ratio could therefore prevent even households from getting a loan which have so far shown only a low default frequency. This could in turn have a negative effect on capital formation with respect to owner-occupied housing in Germany. Last but not least, restricting the maximum loan-to-value ratio would put additional pressure on the already low profitability of banks as a result of the low interest rate environment.

For further information please contact:

Dr. Oliver Lerbs, Phone +49(0)621/1235-147, E-mail oliver.lerbs@zew.de

Prof. Dr. Michael Voigtländer,  Phone +49(0)221/4981-741, E-mail voigtlaender@iwkoeln.de