An alternative to the Hungarian mortgage loan repayment proposal
The proposal submitted to the Hungarian Parliament about the option for early repayment of household foreign currency mortgage loans at a preferential exchange rate has made a stir both inside and outside the country. According to the plan, for example, Swiss franc mortgage loans could be paid back at the fixed exchange rate of 180 […]
The proposal submitted to the Hungarian Parliament about the option for early repayment of household foreign currency mortgage loans at a preferential exchange rate has made a stir both inside and outside the country. According to the plan, for example, Swiss franc mortgage loans could be paid back at the fixed exchange rate of 180 Hungarian forints (HUF), while the market rate is about 237 HUF – the corresponding losses being incurred by the banks. The major goals of the proposal are to strengthen household balance sheets, foster burden sharing, ease the social pain and to reduce the exchange rate dependence of the country.
Let me state at the beginning that I do not wish to comment on the pros and cons of this proposal. Instead, I would like to make an alternative proposal that would be fairer to all parties involved, would most likely not infringe any laws, and would be preferable for those households who wish to repay the foreign currency loan from a new Hungarian forint loan.
But before discussing my proposal, let me briefly summarise the reactions that the parliamentary proposal has received, to put the issue into context.
First, while the proposal may be in line with national laws, the European Court of Justice would most likely find it illegal. Banks and Austrian officials have already indicated that they will take the case there. Second, only those households who have large enough savings or can get a loan from somewhere can make use of this option – guestimates suggest that about one third of indebted households could make use of this, typically the wealthy. But due to the resulting depreciation of the Hungarian forint, other households would find it even more difficult to service their foreign currency loans. Third, some may sell their houses to be able to repay, which would further weaken the housing market. Fourth, banks would suffer heavy losses, which could undermine the financial stability of the country. It could also reduce the lending capacity of banks, which would drag down economic growth and budget revenues. Fifth, the downside risks that may hurt lending, growth and public finances risk a rating downgrade of the Hungarian sovereign, which would have negative consequences. And sixth, such drastic state intervention into private contracts may undermine the trust in the rule of law. However, parliamentarians and government officials assess these risks as low and underline the positive impacts of the proposal.
Now here is my proposal: mortgage interest rates should be specified as LIBOR plus a constant spread – the spread prevailing at the time of granting the loan. This should be done both retroactively and for the future as well.
Most mortgage loans were issued at LIBOR plus 400/450 basis points and most of them are floating rate contracts. The contracts do not specify clearly the way interest rates are to be changed, but have reference to ‘benchmark money market rates’ of the currency denomination of the loan. But while LIBOR went down in the past three years, most Hungarian banks have increased significantly the interest rates of existing mortgage loans. Currently, the average spread is about 780 basis points. In a sense, debtors with performing loans are paying for the bank losses due to non-performing loans.
Therefore, my proposal could be seen as a simple functional formulation of the unspecified link to benchmark money market rates of loan contracts. Since spreads have gone up, debtors have actually paid more compared to what they would have to according to my proposal. These ‘excess payments’ should be regarded as capital amortisations.
My proposal would be fair to debtors. They have to pay the spread they were aware of at the time of taking the loan, but not more, and would have to bear the risk of exchange rate changes that they have deliberately assumed. Very importantly, my proposal would apply to all debtors, and not just to those who have savings or who are able to take a new loan to repay the existing foreign currency loan. Further, those who have recently paid back their debt could also be compensated.
My proposal would be fairer to banks, since they have to pay back the excess interest rate they charged, but do not have to assume the losses of their clients. Also, those banks that were more forceful in increasing the interest rate would have to pay back more compared to those that were modest in this regard. Fairness to banks is important even though banks are certainly responsible for aggressively pushing Swiss franc loans, leading to vulnerability.
And my proposal would be fair to those citizens who do not have foreign currency loans. Should the European Court of Justice find illegal the early repayment and request compensation from the Hungarian government to the banks, this should be paid from the taxes of all – and not just from the taxes of those who actually repaid their foreign currency loans at the preferential exchange rate. Since my proposal can be regarded as the functional formulation of a clause anyway stipulated in most mortgage contracts, it would most probably not be illegal.
In this regard, it is worth noting that, just a few days ago, a court in Hungary declared as illegal the interest rate increases of a particular bank over the past three years and invalidated them. Commentators expect a large volume of similar litigation in the future. But my proposal would go beyond this court decision: since LIBOR has fallen in the past three years, mortgage loan interest rates should have also fallen.
And what would be the difference to a typical debtor? Suppose someone took out a HUF 10 million loan in Swiss francs in January 2007, when the exchange rate was 157, the Swiss franc LIBOR was 2.2% and the lending rate was 6.3% (ie the spread was 410 basis points). The initial monthly debt service was HUF 73 thousand. Today, when the exchange rate is 237 and the lending rate is 7.9% (even though the LIBOR is only 0.1%), the capital value is HUF 13.3 million and the debt service is HUF 125 thousand.
With the early repayment at the 180 exchange rate, HUF 10.1 million is to be paid back. If the repayment were to be financed from a new HUF loan at a 9.5% interest rate, then the monthly debt service would amount to HUF 104 thousand. But if my proposal were to be implemented, then the capital value would be HUF 11.9 million and the monthly debt service would amount to HUF 87 thousand. Therefore, those households who wish to finance the early repayment from a new HUF loan would be better off keeping the Swiss franc loan if my proposal were implemented – unless the forint deprecates by more than 20 % against the Swiss franc, which is unlikely due to the recent decision of the Swiss National Bank to limit the appreciation of the franc.
The macroeconomic impact of my proposal would be also more benign. For example, the exchange rate of the forint would depreciate less (safeguarding those with remaining foreign currency loans, including the government), it would not have a negative impact on the housing market and would reduce less the lending capacity of banks.
The Hungarian Parliament will discuss the early repayment proposal soon and perhaps it is not too late to reconsider the options. But bankers could also consider my proposal voluntarily.
Postscript: The Hungarian Parliament passed the early repayment proposal on 19 September 2011 – on
A version of this article was published in Világgazdaság on 19 September 2010.
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