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MarekMikus
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Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 16th, 2017, 5:20 pm

Hello, I am a social anthropologist doing a research on household debt in Croatia. The country had a lot of problems with FX (namely Swiss franc-indexed) loans as well as loans with variable interest rate loans and many aspects of these products remain controversial and subject to discussion. One interesting issue that keeps coming up in this context is the issue of mortgage-style amortization, also known as amortization with equal payments - simply, the kind of repayment where you as a debtor make the same monthly payment during the entire repayment period (assuming the interest rate is fixed) but the payments initially include a larger share of the total interest and a smaller share of the total principal and this composition continuously changes to the exact opposite, so that the final payment is almost all principal and a little interest. Now, this turned out to be a problem with the Swiss franc loans as the (variable) interest rates on these loans as well as the Swiss franc-Croatian kuna FX have been growing in the same time, which in interaction with mortgage-style amortization meant that debtors in the early stages of repayment of their loans kept up paying a lot of interest (the value of which was constantly growing due to the higher interest rates being charged on the principal which was itself growing to the FX change) and very little interest for a long time. Basically the combination of these three elements - variable interest rates, mortgage-style amortization, and the indexation of the principal to the Swiss franc - proved to be a kind of trap in which debtors found themselves, paying the bank much more than was justified and expected. I hope that this is clear up to now, I am not an economist or finance professional so this might not be absolutely precise or parsimonious and I would appreciate if somebody could correct any mistakes I might have made. NOW I AM GETTING TO MY ACTUAL QUESTION. A claim has come up in some of the interviews I made that mortgage-style amortization is illegal in Western Europe and/or Northern America and is only being used in Eastern European countries such as Croatia where regulation of the banking industry is less stringent and banks generally get away with more. From what I have read, however, it seems that mortgage-style amortization is very far from being illegal in the US at least and to the contrary is widely used there. Anyhow, could you briefly comment if you know about any jurisdictions in which this kind of amortization is illegal, or to the contrary if you are positive that it is actually legal in your country? I am especially interested in the situation in Western Europe, Northern America, Australia and New Zealand but information about other regions and countries is also most welcome. Thank you in advance!
 
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Alan
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 16th, 2017, 7:02 pm

With a fixed interest rate and fixed principal, this kind of repayment is actually the best for most consumers. 

The problems you describe seem to be due to a variable interest rate and changing principal. It indeed seems like a terrible idea to combine all three elements -- simply from a complexity viewpoint. Perhaps it's that combination that has been made illegal in some jurisdictions. But, consider the alternative, which would have probably been interest-only payments with all the principal due at the end. In that case, given the same interest rate and principal changes, the borrowers would now be even worse off -- now owing even more! (If you are bad at math, find a colleague to confirm this for you).

So, the source of their problems seems not so much the amortization, but the other two variables, not to mention poor consumer choices and likely poor disclosure.

My two cents.          
 
MarekMikus
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 17th, 2017, 10:13 am

Dear Alan, thank you so much for your response. I agree that it seems that it was the combination of the three elements rather than mortgage-style amortization itself that turned out to be a problem so my question should be more precisely phrased as whether anybody is aware of any jurisdictions that outlaw such a combination. Interest rate-only payments with all principal due at the end were most likely not really an alternative during the relevant credit boom period (ca. 2000-08) and probably still aren't as I've never heard about anyone with such a loan - it is probably not illegal but the banks don't offer such an option, the banking industry is less developed than in the West and the range of products is more limited. The main alternative would be the fixed principal repayment and the people I discussed this with made it sound like this would help people with the franc loans not fall into that trap of not repaying their principal for years or just very slowly, but on better thought I think it would be also a double-edged sword. Provided the two other elements - the indexation of the principal to the franc and the variable interest rate - stayed in place, the fixed principal part of each installment would be probably defined as a share of the total principal rather than an actual sum (since the repayment was in the Croatian kuna and the maturity was agreed in the beginning, which would not have been possible if the fixed principal repayment was defined as any particular sum - then the maturity would have to be flexible), so the jump in the franc-kuna FX and the parallel increase of the interest rate would increase the monthly installment drastically and presumably even more than with mortgage-style amortization. This would be an advantage over mortgage-style amortization in the sense that it would allow the debtor to repay the principal faster and avoid paying so much interest overall but only as long as they could keep up with the larger installments. If they could not, which seems more likely in Croatia where people tend to have modest and tight budgets, they would run into default in short- to mid-term even more easily. I forgot to mention that another strange practice was loan agreements that allowed the banks to change the adjustable interest rate purely on the basis of their whim, without a link to any parameter like LIBOR or national equivalent, and apparently this resulted in banks hiking up interest rate in the same time as the FX was jumping even though market interest rates on CHF were actually falling and very low during the relevant period (2008-15). This has been since recognized as a breach of the basic principle of contractual equality of parties and outlawed.
 
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ppauper
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 19th, 2017, 9:29 pm

MarekMikus wrote:
NOW I AM GETTING TO MY ACTUAL QUESTION. A claim has come up in some of the interviews I made that mortgage-style amortization is illegal in Western Europe and/or Northern America and is only being used in Eastern European countries such as Croatia where regulation of the banking industry is less stringent and banks generally get away with more. From what I have read, however, it seems that mortgage-style amortization is very far from being illegal in the US at least and to the contrary is widely used there.

it would be interesting to find what the source of that was

it is quite common for auto loans in north america to have equal payments, i.e. amortizing loan.
the exact opposite to what you were told actually appears to be true: consumer loans that are not fully amortized are sometimes regarded as "predatory" because the borrower owes more at maturity than he borrowed initially and  finds he can never repay it
the term they use is "negative amortization" which was prohibited in the US under the 1994 Home Ownership and Equity Protection Act (HOEPA). I believe it was carried over into the newer Dodd-Frank legislation
 
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DavidJN
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 30th, 2017, 2:13 pm

Three things are going on here – the currency of the borrowing, the amortization style and the frequency of the loan rate resetting.  Sounds like western banks lending in eastern European shifted the risk of foreign exchange and interest rate risk onto the borrower, seemingly with disastrous effect.
 
In Canada, our oligopolistic banking system has largely pushed interest rate risk onto borrowers by offering fixed rates for periods no longer than 5 years. The amortization periods are typically 30 years but the fixed rate gets reset every five years (this type of mortgage tends to be called an ARM or adjustable rate mortgage in the US).
 
Having said this, a lot of Canadian borrowers have successfully saved big time on interest costs by instead borrowing at floating rates over the last ten years or so. Here is an interesting institutional wrinkle – in Canada a borrower with a variable rate mortgage actually makes fixed monthly payments based on a 3-5 year term fixed mortgage rate, and any excess payment (usually an excess when the yield curve is upward sloping) is used to pay down the principal and serves to thus shorten the duration of the loan.
 
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Cuchulainn
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 30th, 2017, 5:52 pm

Is an amortizing mortgaage the same as annnuity?

https://www.ccpc.ie/consumers/money/mor ... -mortgage/

These were (probably still are?) popular in Ireland and have recently become popular in the Netherlands because total mortgage debt has risen to 600 billion Euri. 

Coupling to the CH Frank must be a nightmare.
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Traden4Alpha
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

June 30th, 2017, 7:19 pm

As an anthropologist, you might also think about the preferences and behaviors of the lenders, too. Under what conditions might someone in another country voluntarily lend money to someone in Croatia? If the lender does not trust the stability of the kuna or the stability of long-term interest rates, they may only lend money under variable-rate terms or with payment in FX. Also note that the lender may well have fiduciary responsibilities to their depositors who are the citizens of another country.

If Croatia does not have enough domestic capital to cover the country's demand for mortgages, then its banks and regulators may face a stark choice between providing fewer loans at higher interest rates or offering more loans at lower interest rates but also with controversial lending terms such as reseting rates and payment in a foreign currency.

The deeper anthropological issue is the regulation of complexity in human relations -- what kinds of long-term deals should people be allowed to make (along with the social consequences of that allowance or prohibition). Variable-rate, FX-denominated mortgages are not universally bad. Such loans do offer higher initial affordability and have no downside if the borrower has increasing income or plans to sell the house prior to the loan reset. But they do depend on the borrower understanding the implications of the loan structure which some may well understand, others may not, and the lender may make comprehension easier or harder. Variable rate loans may be risky for the borrower but fixed-rate loans may be risky for the lender (and the lender's depositors).
 
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Cuchulainn
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

July 1st, 2017, 12:31 pm

Eastern European countries such as Croatia 

Personally I had never thought of Croatia being part of EE, certainly not geographically. 
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Traden4Alpha
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

July 1st, 2017, 1:28 pm

Cuchulainn wrote:
Eastern European countries such as Croatia 

Personally I had never thought of Croatia being part of EE, certainly not geographically. 
It's as east as Czechoslovakia, Poland & East Germany, was part of Yugoslavia, and has a Slavic language.
 
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Cuchulainn
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

July 1st, 2017, 2:06 pm

Traden4Alpha wrote:
Cuchulainn wrote:
Eastern European countries such as Croatia 

Personally I had never thought of Croatia being part of EE, certainly not geographically. 

It's as east as Czechoslovakia, Poland & East Germany, was part of Yugoslavia, and has a Slavic language.

'East' as a general name for 'Communist'. Somewhat of a misnomer. At one stage it was part of the Balkans.

And .. Croatia is a member of EU since 2013, yes?

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ppauper
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Re: Regulation of Mortgage-Style Amortization Loans: Comparisons Between Countries

July 2nd, 2017, 9:28 am

I too think of  "Eastern Europe" as have being a synonym for the communist block.

And I would say that geographically, the balkans  (including croatia) is part of eastern europe, because it abuts asia in the form of asia minor
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