The Danish system is unique, as there is a direct match between the mortgage loan and the covered bonds issued to fund the loan. This provides for a high level of financial stability and forms the basis for transparent competitive loan costs and a flexible early repayment system found nowhere else in the world.
How does the mortgage system work?
The acquisition of real estate in Denmark is typically financed by mortgage credit institutions, which are dedicated financial institutions permitted only to grant loans against mortgages on real estate funded by covered bonds.
The mortgage system is generally based on a match-funding principle, under which mortgage loans are funded by the issuance and sale of covered bonds with matching payment terms. The market value of the underlying bonds at time of sale determines the mortgage loan rate, thereby ensuring a high level of transparency based on market pricing.
The loans are secured through a mortgage on the borrower’s property, and all loans are limited to the statutory maximum loan-tovalue ratio based on the assessed value of the property; 60 percent for commercial properties and 80 percent for residential rental properties.
In addition to the property value, the borrower’s creditworthiness is individually assessed as part of the credit approval process and the mortgage security will often be combined with other types of security in the form of change of control, negative pledge, limitations on dividend distribution and, depending on the circumstances, pledge over the shares in the borrowing company or suretyship.
Key advantages of the Danish mortgage system
The Danish mortgage system offers several advantages due to the unique features of the match-funding principle and the high level of security, including:
- Competitive loan costs
- Transparent market-based pricing
- Flexible early repayment options with no penalty
- Long credit facilities (up to 30 years)
- Possibility for interest-only financing
- Mortgage credit institutions cannot terminate the loans except in the event of default
Danish mortgage credit institutions offer three main types of mortgage loans, namely: fixed-rate loans, adjustable-rate loans and floatingrate loans (with or without interestrate caps), which are all standard loans. Almost all loans may be combined with interest-only periods for up to ten years, subject to individual credit approval.
Fixed-rate loans are typically longterm loans with a term of up to 30 years, providing for a high degree of security as the interest payments are known throughout the term of the loan. A fixed-rate loan can be either a cash loan or a bond loan, where the main difference is that any capital loss on the sale of the underlying bonds is reflected in the interest rate on the cash loan instead of in the proceeds, as is the case with bond loans. Any capital loss on cash loans is therefore tax deductible, as the loss is converted into interest.
With adjustable-rate loans, the interest rate is adjusted throughout the term of the loan at certain intervals from one year and currently up to ten years, at which time the underlying bonds are redeemed and replaced with new bonds. The yield of the new bonds will then determine the interest rate of the mortgage loan until the next adjustment time. The adjustable-rate loans are cash loans, and any loss or profit on the sale of the underlying bonds is therefore reflected in the interest rate.
The interest rate on floating-rate loans is adjusted at more frequent intervals, generally every three to six months, and the interest rate is typically based on a reference interest rate, usually the Copenhagen Interbank Offered Rate (CIBOR) or the Copenhagen Interbank Tomorrow/Next Average (CITA), plus a premium. A floatingrate loan may be combined with an interest-rate cap.
Whereas adjustable-rate and floating-rate loans provide a lower interest rate, fixed-rate loans provide for equity-value protection in a market with increasing interest rates, as the market value of the fixed-rate loans will decrease when interest rates increase, making it possible to repay the loan at a lower amount.
Competitive loan costs
The liquidity of the mortgage bond market and the attractiveness of the bonds due to the high level of security ensure low and competitive prices.
The recurring loan costs consist of interest and principal payments as well as a margin charged by the mortgage credit institutions. The interest rate of a mortgage loan and the repayment price is directly reflected in the price of the mortgage bonds funding the loan. The interest rate is therefore based on the chosen loan type and the market price and is not subject to individual negotiation.
According to the European Mortgage Federation (EMF), Denmark has one of the lowest interest rates in Europe. For foreign investors, it should be noted that Denmark conducts a fixed exchange rate policy, keeping the value of the Danish krone stable against the euro.
The margin charged by the mortgage credit institutions is a percentage of the debt outstanding and corresponds to the interest margin of a universal bank; however, the rate is generally lower. The margin percentage is subject to individual negotiation and may be adjusted during the term of the loan, unless otherwise agreed.
In addition to the recurring loan costs, there will be initial costs such as commitment fees, brokerage and costs for registration of the mortgage in the Danish Land Register. The registration fee amounts to 1.5 percent of the mortgage debt plus a low fixed-fee amount. However, the borrower may, under certain circumstances, be able to reuse registration fees on mortgages already registered on the property.
Flexible early repayment options
A common feature of mortgage loans is an early repayment option, providing for a high degree of flexibility for the borrowers in terms of exit and mortgage refinancing in a changing market. These repayment options depend on the loan type.
Fixed-rate loans are based on callable bonds and can always be terminated for early repayment at par value. In addition, the loan may be repaid by purchasing and delivering the same type of bonds as those used to fund the loan.
Adjustable-rate loans are based on non-callable bonds and can only be repaid at par value in the two-month period prior to the interest-rate adjustment. However, the loan may, at any time during the remaining periods, be repaid by delivery of the underlying bonds. The repayment options for floating-rate loans depend on whether the loan is based on callable or non-callable bonds.
It is therefore possible to repay all loan types without negotiation or penalties, but, in case of repayment by delivery of the underlying bonds, the price will be based on the market price for the bonds at time of purchase.
No termination without cause
A final main characteristic of mortgage loans is the borrower’s security against termination without cause. Mortgage loans are nonterminable in that mortgage credit institutions are not entitled to terminate a mortgage loan except in the event of default, and the loans are not subject to renegotiation every year as is the case with bank loans.