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Housing Finance: Latin American Issues and European Views Chile: New Market Developments Felipe Morandé Deparment of Economics University of Chile Paris, June 2003
Main factors in the development of the housing finance market in Chile in the 20 th century: I. Inflation II. Public Housing Policy III. Capital Market Development
I. Inflation • From the forties until the early nineties, the Chilean economy was marked by high and variable inflation rates. • Nominal interest rates did not compensate high inflation. • In the sixties, indexation mechanisms were incorporated to saving accounts and long term credits. The Unidad de Fomento (UF, a daily unit of account indexed to past inflation) was created in 1967. • Savings and Loans Institutions (Associations, AAPs) were inaugurated in the early sixties, following the American model. They collapsed in the seventies after financial deregulation and economic turmoil.
II. Public Housing Policy • It´s main goal has been to facilitate homeownership to low income people, which have less chance of accessing the housing financial market. • As of lately, this policy has been increasingly using demand subsidies (which decrease with income levels) and has been gradually withdrawing the State as a house supplier.
III. Capital Market Development • The continuous development of the capital market and the increasing macroeconomic stability have allowed a greater sophistication in the housing financial markets: long term loans (in local currency), deep secondary markets (including securitization) with active and large institutional investors, housing leasing, etc. • Thus, housing financial markets are mature enough for new improvements in order to achieve greater depth and development.
Housing Mortgage Operations
Housing Mortgage Operations as % of GDP
Housing Mortgage Operations as % of Total Banking Loans
Proposals for Deepening Housing Financial Markets 1) Increase the maximum loan-to-value (LTV) limit for mortgage titles from 75% to 80% 2) Implement Mortgage Insurance 3) Reduce cost of housing leasing 4) Implement Property Title Insurance 5) Develop of “Pre-Building Approval Insurance” 6) Facilitate access of people over 60 years of age to housing financing 7) Develop of Reversed Mortgage
1. Increase the Limit of Housing Finance • It does not increase the Banks´ risk, since today they finance up to 90% with complementary credits. • Price reductions in houses have been less than 20% in worst recession. • A 5% increase is not going to affect the problem of asymmetric information. • In most developed countries the average limit (explicit or implicit) is 80%. • Allows a reduction of credits costs. • Would have a marginal effect on institutional investors’ current holdings of mortgage titles. • Would have a marginal effect on banks’ credit ratings.
2. Mortgage Insurance • They protect both the lender and the institutional investor in case that the debtor does not pay and the value of the guarantee (house) is not enough. • Mortgage insurance requirements are similar to credit requirements. • It does not protect the borrower.
2. Mortgage Insurance The benefits of this type of insurance are quite clear, the main issue are the costs. Costs should be equal or inferior to the combined cost paid today by the borrower who finances more than 75% by using mortgage loan complementary credit. International experience indicates that the cost of insurance fluctuates among a 0. 5 and a 5% of the mortgage value, according to the country and the payment mode. Under reasonable assumptions, an insurance costs estimation in Chile would be of 4. 8% of the property value.
3. Cost Reduction of House Leasings are today an alternative that allow financing up to 95% of the property value. This alternative has been used primarily in houses priced below US$ 35. 000 However, costs in house leasings are higher than what banks or mortgage loan corporations (MLC) usually charge, since the main financing source for leasing is securitization which displays some problems.
3. Cost Reduction in House Leasing Proposals: Facilitate the securitization process by making it cheaper and periodic. This would allow a reduction in financial leasing costs. Develop an interest rate swap market. This will help reducing the interest rate risk of lending institutions (banks, leasing companies and others) in the credit accumulation process before securitization.
4. Property Title Insurance In Chile, “Legal Title Reports” by lawyers are used to check for title validity and diminish title risk. However, these reports: • Delay the transaction beyond reasonable time (up to 15 days) • Neither compensate nor guarantee in case of errors • They are costly (approximately 0, 2% of average valued properties, US$ 50. 000) • Every loan renewal or property transaction requires a new title report (with the same cost); there are not scale economies)
4. Property Title Insurance The implementation of Property Title Insurance implies the following advantages: ü Protection of homebuyers ü Protection of lending institutions and institutional investors (collateral) ü Efficiency due to specialization (24 a 72 hrs. ) ü Reduction of loan renegotiation (50% to 60% discount in the insurance cost) ü Economies of scale in case of real state developments ü Development of a secondary market for mortgage loans These advantages imply savings for the economy of more than US$ 10 million per year (or around US$ 200 million in present value)
5. Pre-Building Approval Purchase (Pre-sold) Insurance • Pre-building approval contract: is the sale which is carried out before the definitive building approval by the city government (Municipality). This contract is a legal promise that involves some form of a down payment by the buyer for the right to close the purchase and have the property title when the building is finished and approved by the municipality. • An insurance policy guarantees the buyer that he will be reimbursed of the amount paid in advance if the building is not finished. It could also contemplate the coverage of compensatory damages.
5. Pre-Building Approval Purchase (Pre-sold) Insurance • At the moment, between 36% and 45% of properties are sold with a pre-building approval purchase contract, but less than a third is done by using coverage provided by insurance companies. • The policies costs fluctuate between 0. 8 and 5% of the insured amount. Much more than in Spain (0. 3 to 1. 2%). • What is needed to be done to diminish the cost and spread the use of this insurance? Apply a mechanism already in use in Spain: the real estate company can only use the incomes coming from pre-construction purchase payments in the same project, restriction which can be controlled by the insurance companies. • Social benefit: reduced cost of housing.
6. Mortgage Loans for People over 60 years old • There is a significant potential demand of people over 60 year old for mortgage loans: those that buy their first house, those that wish to move, and those that want a second one. • The main restriction for the elder in order to obtain a mortgage loan, is to get a Mortgage Life Insurance (which is granted only to people in good health conditions). • Banks and institutional investors require Mortgage Life Insurance in order to issue mortgage loans.
6. Mortgage Loans for People over 60 years old Proposals: • Old people usually have some wealth (perhaps a house) that can use as collateral for a loan, or for a mortgage. So the main point is that banks can lend them money with a low loan-to-value limit and exempt them from having mortgage life insurance. In case of death, the house should be liquidated and the proceeds go to the lending bank. • Leasing operations financed with leasing corporations own capital can also be offered (although they would be more expensive)
7. Reversed Mortgage • The owner of a house requests a loan against his property value. He/She can make liquid his/her property while still living in it. • Unlike a traditional mortgage, it does not require a reimbursement of the loan while the applicant lives in the house. • The amount of the mortgage is determined among other things by the applicant age: the higher is the age of the applicant, the greater is the percentage than it is possible to be borrowed. • Cultural barriers? Bequest motive?
Goals to be achieved • The first three proposals point towards facilitating access to home financing to people that do not have (yet) saving capacity to make the down payment. • Proposals four and five focus on reducing transaction costs. • The last two proposals look for more financing opportunities for elder people. • But overall, the seven proposals are for deeper and more complete housing financial markets in a environment in which this is feasible.