Fitch: Stable Instalments Shorten German Mortgage Loan Terms
OREANDA-NEWS. The average loan terms of German residential mortgages are falling as the amortisation portion of instalments has increased in response to low interest rates, Fitch Ratings says.
Our analysis of 310,800 loans in Fitch-rated covered bond and structured finance deals shows average terms shortening in recent mortgage originations. Average terms for new originations fell to 19 years in 2015 from just over 25 years in 2010 as amortisation rates have increased.
Average interest rates dropped to around 2% in 2015 from 4% in 2010 on loose ECB monetary policy and high competition between lenders. However, the instalments remained constant at 7%-8% with repayment rates increasing in inverse proportion to the decline in interest rates.
Higher repayment rates are generally credit positive as they reduce both an annuity loan's term and the balance at default during the loan's term. In addition, higher repayments reduce the size of the payment shock at a fixed-rate loan's interest reset date if interest rates have risen significantly, by reducing the balance of the loan more quickly in the period leading up to the reset date.
Not all lenders have adopted this approach. For example, our data from Postbank's mortgage covered bonds shows that average instalments dropped by 1.7pp to around 5% between 2010 and 2015. This contributed to longer contractual mortgage terms (just over 35 years for loans originated in 2015). While longer terms imply a higher risk of default, the lender has partly compensated for this by lengthening the term to the interest reset date to, on average, 15 years (compared with 10 years in 2010). Again, this lowers the risk of a significant payment shock, reducing the impact of increasing interest rates on a borrower's ability to pay at reset date.
Moreover, Postbank generally offers loans with optional prepayment rights and/or options to change the repayment rate. If borrowers take these up, the expected term of a mortgage can be significantly shorter than the contractual term. For example, an annual prepayment rate of 2% of the original balance would reduce a loan's contractual term from 35 years to 20.
In our RMBS criteria, amortisation, loan terms and repayment schemes affect a mortgage portfolio's total loss expectation, because amortisation reduces the exposure at default and shortens the potential default horizon. As a consequence, higher repayments - and shorter terms - will bring down the loss expectations we calculate in our German RMBS and covered bond analysis.
We do not use the term to reset date as a separate input, as we take comfort from banks' affordability tests at origination. Prepayments are not used in our loss calculations because they are less predictable and vary with changes in the economic environment.
Fitch-rated German RMBS transactions are currently experiencing very low and stable 3m+ arrears, reflecting Germany's economic growth and low unemployment. We expect this robust performance to continue (we forecast 3m+ arrears at 0.5% in 2016), partly because we think the macroeconomic backdrop will remain supportive, but also because, overall, lenders are not relaxing credit standards and reducing instalments to sell mortgage loans to consumers that could otherwise not afford them.