Has the Variable Rate Mortgage Saved the European Mortgage Market?

Just as in the United States, many European countries have had large run-ups and crashes in house
prices. Consider the data from the European Central Bank below: one sees in particular large price increases and declines in Spain and Ireland.

(click to enlarge)

Remarkably, default rates in Ireland and Spain in 2009, while high by historical standards at 3.6 and 2.9 percent respectively, were substantially lower than in the United States, where the default rate was 13 percent (see Fiorante and Mortgage Bankers Association of America). Dwight Jaffee has argued that this difference in performance is the result of the fact that mortgages in Europe give lenders recourse to the borrower. I find it plausible that recourse matters, but not that it matters quite so much. For example, while purchase money loans in California are non-recourse, refinance loans are not. The preponderance of mortgages in California are refinance loans, and California’s default rate is extraordinarily high.

So why haven’t borrowers in Spain and Ireland defaulted more? According to the European Mortgage Federation, more than 80 percent of loans in Spain and Ireland are variable rate mortgages. As a consequence, as market interest rates fell, so too did mortgage interest rates. The typical mortgage borrower in Ireland and Spain is currently paying considerable less than 4 percent on their mortgage.

This has almost certainly been beneficial to Europeans, and suggests that robust TARP 2 program, where underwater borrowers can refinance their loans at lower interest rates, could help mitigate default. On the other hand, as interest rates rise in Europe, we might have reason to become very, very concerned about defaults there in the months to come.

About Richard K. Green 103 Articles

Affiliation: University of Southern California

Richard K. Green, Ph.D., is the Director of the USC Lusk Center for Real Estate. He holds the Lusk Chair in Real Estate and is Professor in the School of Policy, Planning, and Development and the Marshall School of Business at the University of Southern California.

Prior to joining the USC faculty, Dr. Green spent four years as the Oliver T. Carr, Jr., Chair of Real Estate Finance at The George Washington University School of Business. He was Director of the Center for Washington Area Studies and the Center for Real Estate and Urban Studies at that institution. Dr. Green also taught real estate finance and economics courses for 12 years at the University of Wisconsin-Madison, where he was Wangard Faculty Scholar and Chair of Real Estate and Urban Land Economics. He also has been principal economist and director of financial strategy and policy analysis at Freddie Mac.

His research addresses housing markets, housing policy, tax policy, transportation, mortgage finance and urban growth. He is a member of two academic journal editorial boards, and a reviewer for several others.

His work is published in a number of journals including the American Economic Review, Journal of Economic Perspectives, Journal of Real Estate Finance and Economics, Journal of Urban Economics, Land Economics, Regional Science and Urban Economics, Real Estate Economics, Housing Policy Debate, Journal of Housing Economics, and Urban Studies.

His book with Stephen Malpezzi, A Primer on U.S. Housing Markets and Housing Policy, is used at universities throughout the country. His work has been cited or he has been quoted in the New York Times, The Wall Street Journal, The Washington Post, the Christian Science Monitor, the Los Angeles Times, Newsweek and the Economist, as well as other outlets.

Dr. Green earned his Ph.D. and M.S. in economics from the University of Wisconsin-Madison. He earned his A.B. in economics from Harvard University.

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