Housing wealth and indebtedness - growing differences between generations?

Anneli Juntto, anneli.juntto@uku.fi, University of Kuopio, Finland Markku Säylä, markku.sayla@stat.fi, Statistics Finland

Olli Kannas, olli.kannas@stat.fi, Statistics Finland

Housing wealth and indebtedness

-Growing differences between generations?

Essential differences between generations in wealth accumulation and indebtedness can arise as a result of structural system changes. This happened in the Finnish housing finance system at the turn of the millennium. The traditional characteristics and problems of the housing mortgage system changed radically. Older generations used to pay their housing loans in 5-10 years, for the young generation the loan period for purchasing their homes can be 30 years or more, but under 20 years, on the average, though.

This paper estimates the possible negative effects from this, which poses a growing risk of over-indebtedness for young entrants to the housing market. We use in our analysis the data from Statistics Finland’s Wealth Surveys from 1998 and 2004. Very low current interest rates tempt new entrants to the housing market to take big loans. In the Risk Society, young entrants to the housing market are themselves responsible for forecasting the future. When housing is distributed through the market mechanism, the risks are passed on to the market actors and especially to young people. In a time that emphasises individuality, the individuals must also be able to calculate very complicated risks. The differences in wealth, and especially in indebtedness, between generations are growing. New home owners are highly mortgaged and pay a high share of their income for housing, and will

Anneli Juntto, anneli.juntto@uku.fi, University of Kuopio, Finland Markku Säylä, markku.sayla@stat.fi, Statistics Finland

Olli Kannas, olli.kannas@stat.fi, Statistics Finland 20 June 2006

Housing wealth and indebtedness

Growing differences between generations?

“Debt is your brother when you take it but your enemy the day you must pay it back.” (Old Finnish saying)

Essential differences between generations in wealth accumulation and indebtedness can arise as a result of structural system changes. This happened in the Finnish housing finance system at the turn of the millennium. The traditional characteristics and problems of the housing mortgage system, such as very short housing loan terms, changed radically. Liberation of the housing finance system from the previous strict regulation of the central bank had started in Finland already in the 1980s. However, the effects were postponed by a very severe economic recession and a crisis on the housing market in the early 1990s. Now, in the early 2000s, loan periods have started to lengthen substantially. This paper estimates the possible negative effects from this - as such a positive improvement of housing finance terms. Young entrants to the housing market face a growing risk of over-indebtedness. Very low interest rates tempt entrants to the housing market to take big loans. As data sources for our analysis we use Statistics Finland’s Wealth Surveys from 1998 and 2004.

In the Risk Society the house buyer is responsible for forecasting the future

Housing is supplied and distributed increasingly through the market mechanism. This means that the risks are passed on to the market actors and especially to the entrants to the housing market. In the Risk Society of Ulrich Beck (1986), risks get all the more opaque and all responsibility in the end stays with the individual and household. In a time that emphasises individuality, life control obliges individuals to calculate very complicated risks. In a way they are expected to analyse the future continuously.

space or wish to move to better housing. If the loan period is 30 years or more, by the end of it the dwelling may even required major renovation.

Taking out a housing loan means taking financial risks. What are the possibilities of different

households to protect themselves against risks arising from the development in housing prices, interest rates and expected incomes? How aware are households of the risks connected with the new terms of housing mortgages? The present terms of housing finance are new in Finland; they have changed from the practices people were used to. In the past, regulations of the Bank of Finland functioned as a buffer. The high proportion of own savings banks expected protected home buyers from debt risks. The bankruptcy option to leave the estate and its debts that is offered in the United States does not exist in Finland (Hyytinen 54). In Finland, housing loans are personal and follow the debtor. For some years now, it has been possible to apply for debt conciliation, but the process is difficult and demanding.

When the size of a housing loan is big and the loan period long, the risk of becoming over-indebted grows, especially in the first years. Actual loan repayment is very slow in the first years of so-called fixed-term annuity loans, while later on the share of interest, as well as the risk diminish. Young people in Finland also often work in short-term jobs, some of which can be precarious. Various changes can also occur in life.

Housing prices have been very volatile in Finland. Improved terms of housing loans have become capitalised into housing prices. Home buyers have not always benefited from them, and the supply and construction of housing has not met the demand in Finnish growth centres.

Average hides very different situations

Table 1: Changes in housing financing terms in Finland

1970-1980 Loan periods (5-8 years), rate of interest and loan to value were regulated by the Bank of Finland. Loan to value only 40%, savings must make up 40-50% of purchase price

1980 Savings 30%

1986 -1989 Liberation of credit market begins, loan to value even 100%, overheated housing market crashes in 1989

1990-1995 Severe recession, extremely high interest rate (1993 14-16%), 25% savings expected

1996 Period of declining rate of interest and rising house prices

2004 lowest interest rate in EU

2006 Unsure future, slight rise in interest rates from May 2005, house prices continue to rise

The Finnish Bankers’ Association makes frequent surveys of housing debts. The newest survey is from spring 2006. We use data from this study for background analysis, while later on in this paper our main data source is the 2004 Wealth Survey. According to it, the average loan was EUR 20,300 in 1998 and EUR 58,300 in February 2006. In 1998, the average repayment period for housing loans was 11 years, but by 2006 this had already gone up to 17 years. (Finnish Bankers’ Association 2006, 12-14) The bigger and newer the housing loan, the longer the loan period. Of the housing loans taken in 2003-2005, 43 per cent had a loan period of 20 years or more. One-half of the biggest housing loans had repayment periods of at least 20 years, i.e. 50 per cent longer than for medium size housing loans. (Finnish Bankers’ Association 2006, Niininen & al. 54) The amounts paid monthly in interest and repayment did not, thus, grow linearly pro rata to the size of the housing loan. All this increases the risk of indebtedness. If the repayment period is long from the start, it contains no element of

flexibility. In Finland, the loan period is often used as a buffer: if anything changes, the monthly annuity remains the same.

Finland. However, we are only mid-way through the transformation process in housing finance by international comparison.

Effect on the housing market

A European Central Bank report (2003) comments that the development in house prices has been also otherwise very volatile in Finland, especially in the nineties. One explanation to the unstable

development on the Finnish housing market may be that the supply, i.e. housing production, has been and is very unresponsive and “rigid”. Dwelling prices react strongly to fluctuations in demand. However, housing prices have not risen as “explosively” as in Britain, Spain and France since 2000. (Herrala 2005.)

At the moment, dwelling prices in Finland are relatively high; they have risen continuously since 1996 with the exception of a brief recession in 2001. Behind this is the housing market’s high sensitivity to slight increases in interest rates, so a temporary rise in the interest rate lowered house prices in 2001. When the interest rate began to decline, housing prices started to go up again. At its lowest, the interest rate was under 3 per cent.

Figure 2: The rate of interest of housing loans in Finland 1992-2006, Bank of Finland

Rent control was abolished in Finland in 1995; rents have risen in the 1990s. Private renting has become more expensive than buying a dwelling with the current low interest rate. Development of the interest rate has driven the Finnish housing market in the past few years. This can mean that young people buying their first dwelling become subjected to over-indebtedness. Strong growth of housing loans can also otherwise risk balanced price development on the housing market.

For decades, undeveloped housing finance and short-term loans have been a curse to home buyers in Finland. Now the availability of housing credit is no longer a problem. (Herrala 2005) However, the demand for better housing and more spacious dwellings arising from improved housing finance conditions is a challenge to housing production. In the past, regulations restrained the development of housing standards. Dwellings are smaller in Finland than in many other EU countries. Finland is the only country of the EU15 where the average floor area of a dwelling is less than 80 square meters. As housing finance now offers better conditions and longer mortgages, the wish of young households to acquire better housing is suddenly possible. They have high expectations about housing standards. However, the necessary prerequisite is that the housing supply is sufficient. Otherwise the benefit becomes capitalised into housing prices. In growth centres, we now live in the producer’s and not the buyer’s market.

is easier now, and a variety of loan guarantee and insurance options are available. Young people are thus able to purchase bigger dwellings. This positive development contains risks, such as that of over-indebtedness in some cases.

The future perspective of house buyers has suddenly changed and lengthened. Expected permanent income is more and more important to home buyers. The level of real income affects the decisions made on the housing market. For example, in the 1990s housing sales almost stopped because of declining real income and unsure employment. Young house buyers’ horizon on expectations is long; they have many working years ahead of them. When the interest rate on housing loans is very low, like now, this is projected into the future and thus improves young buyers’ solvency at the moment. They are able to purchase better quality dwellings. House purchasers can overestimate their own future pay potential; there is no guarantee that the interest rate will remain low. The ideal loan period is very sensitive to changes in interest rates. The problem is the first ten years, when the loan to value ratio and the share of paid interest of housing costs are high.

Wealth Survey 2004

Statistics Finland conducts an extensive Wealth Survey every four to six years. The latest survey was carried out in 2004 and the one before it in 1998 (Säylä 2006). The 2004 Wealth Survey also

contained questions about housing preferences; the survey questions about subjective experiences of indebtedness are also used in this paper. The data were collected with interviews lasting about one hour. In addition, data covering income, debts, etc., were used from administrative registers. In this paper we use data from these two surveys to compare different age groups, or cohorts, by their housing assets, housing loans and loan to value ratios.

Both housing wealth and debts more bound to life span

The size of the housing loan of a great majority of the households with a housing loan in Finland was under EUR 100,000 in 2004. Only three per cent had a housing loan exceeding EUR 150,000. In the 25 to 34 age group, six per cent, but in the 45 to 54 age group only two per cent of households had a housing loan of EUR 100,000 or more. Young people, new entrants to the housing market, had the biggest, and elderly couples aged over 65 the smallest loans.

The size of the average housing loan has almost doubled in the 25-35 age group and grown by one-third in the 35-44 age group over the 1998-2004 period. The majority, or 85 per cent, of the housing debtors in Finland had housing loans of under EUR 100,000 in 2004. (Wealth Survey 2004, Statistics Finland, Säylä 2006)

Figure 2: Gross and net (loans deducted) wealth by age of head of household in 1998 and 2004, Wealth Survey, Statistics Finland

Alle 25-y 25-34-y. 35-44-y. 45-54-y. 55-64-y. 65+ v

0 50 000 100 000 150 000 200 000 250 000 EUR perhousehold

1998 G

1998 N

2004 G

2004N

An explanation to this is can be found in the turbulence of the Finnish housing market in the 1990s. During the economic recession, the demand for owner-occupied dwellings diminished and young households, entrants to the housing market, chose to live in rental dwellings. At the beginning of the 2000s, especially from 2002 onwards, when the interest rate declined more or less permanently to below 4 per cent, young households began moving to owner-occupied dwellings. Year 2004 is the first one when this change also shows in housing statistics. As a result, the gross wealth of young

households has grown in 2004 when compared to 1998.

0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0 All Under 25-y

25-34-y. 35-44-y. 45-54-y. 55-64-y 65y

-1998 2004

The average loan to value (LTV) ratio was not alarmingly high in 2004 (Figure 3), when it was 63 per cent for households aged 25-34, but 13 per cent for the 45-55 group and six per cent for households aged 55 to 64. (Wealth Survey 2004)

Table 2: Household’s loan term and age of head of household in 2004, Wealth Survey, Statistics Finland Under 35 y. 35-44 y. 45-54 y. 55-64y. 65 y. - All Under 5 1,3 1,7 4,9 5,9 8,4 3,2 5-9 2,4 2,0 15,7 17,0 44,3 9,0 10-19 36,2 62,7 62,4 58,1 30,1 54,2 20-29 57,3 30,9 17,0 13,3 10,7 31,0 30 - 2,8 2,6 . 5,8 6,5 2,5 Sum 100 100 100 100 100 100 N 257 378 303 113 29 1080

The majority of the households aged under 35 already had a loan period of at least 20 years in 2004, and for the middle-aged households between 45 and 54 the mean ranged from 10 to 19 years. (Wealth Survey 2004)

Subjective experiences

The Wealth Survey also included questions about financial difficulties experienced by households. One households in four with a housing loan had experienced at least some difficulties with their housing expenditure. The size of the housing loan did not seem to be connected with the experienced burden of housing expenditure. Eight per cent of households had difficulties in managing their housing expenditure. Paradoxically, the households with housing loans of over EUR 150,000 had less

To around four per cent of the housing debtors the loan burden had grown so heavy during 2004 that they could not cope with it. The distributions were very alike by size of mortgage and age of debtor. The bigger the housing loan, the greater the share of the debtors who felt they could handle a rise in mortgage costs due to possible rise in the interest rate.

Of all house debtors, 92 per cent expected their income or wealth to increase or remain unchanged during the next three years. The majority of young debtors expected their income or wealth to grow or stay at the same level over the next three years. There was no clear connection between size of

mortgage and income expectations. It was surprising that almost one in ten of the debtors with a big housing loan of over EUR 150,000 expected their income or wealth to diminish in the near future.

The results make it possible to draw the conclusion that in spite of the bigger mortgages taken by young debtors and the longer loan repayment periods, young people have not experienced more paying difficulties than other households. Young peoples’ expectations are at least as optimistic as those of other age groups. Young people may be better prepared for the additional costs brought on by possible rises in interest rates.

Conflict between generations?

The indebtedness problem in Finland should not be exaggerated. Up to now it has been an unrecognised risk. In international comparisons, the Finnish credit market is characterised by a relatively low average (!) housing loan burden. The problem is that although the average is very reasonable it hides a very uneven distribution of the housing debt by age and life span. In Finland, like in Britain, the interest rates on housing loans are mostly flexible (bound to Euribor or Prime), and can change quickly if the general interest rate goes up. This also makes it difficult for home buyers to forecast their future finances and expenditure. Rises in house prices also have a negative side effect as they may cause major changes to the future consumption possibilities of the young generation.

There are risks contained in the housing financing system, arising principally from the development of interest rates. However, these risks seem to be faced and carried individually. Even young households have very different situations and wealth expectations. A possible debt crisis is not shared but must be managed by an individual. Risks have been individualised according to the logic of modernism. New and old values sometimes blend very flexibly. The traditional Finnish values that expect everyone to cope with their own housing and the new individualism come together and maybe help entrants to the housing market to control their situation. The means for coping with the situation and possible rises in interest rates are also individually customised.

Literature:

Beck Ulrich (1986): Risk Society

European Central Bank (2003): Structural factors in the EU housing market. March 2003.

Herrala Risto (2005): The housing market and household indebtedness in Finland. Bank of Finland Bulletin 2/2005. 29-37

Hyytinen Ari, Johansson Edward, Määttänen Niku (2006): Omistusasunnon ja asuntolainan rooli kodin taloudessa (The roles of an owner-occupied dwelling and housing loan in household finances, in Finnish only). The Finnish Economic Journal 1/2006, pp. 48-66

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Säylä, Markku (2005): Housing expenditure. Construction and housing yearbook 2005.