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April 14, 2022

Galym Khusainov    

Why mortgages in Europe are 3%, while we have 18%    

Even before all the events, I conducted a survey on the topic of the next post, but the events in Ukraine knocked the focus and I had to postpone this issue. Finally, I decided to write about the rate in simple terms.   

The interest rate on a loan, including a mortgage, consists of the following components:

  1. The cost of funding the Bank. Funding for mortgage programs is based on deposits of individuals and bonds issued by second-tier banks (STB). Ideally, funding should come from bonds. Now Banks attract resources on average at 12-13% after the base rate has been increased. Previously, the average attraction rate was around 10-11%.    
  2. The cost of risk per borrower. If the borrower becomes problematic and does not repay the debt, then all losses on this borrower are transferred to the cost of risk and included in the rate. In other words, good borrowers always pay for bad borrowers. Not all borrowers can be ideal, and the higher the risk appetite of STB, the worse borrowers STB appears and the higher the cost of risk is laid down. But there is also another element here. In many respects, the cost of risk depends on the regulatory process of collecting bad debts and selling collateral. Now, on average, the recovery of collateral and its sale takes 3 years. Of these three years, the borrower does not pay interest for 2.5 years. With the cost of money at 13% (and the STB pays those from whom it took the money), the loss is 37%. Accordingly, the STB must cover all losses through the sale, but as a rule, the apartment that remains from the borrower from the renovated apartments turns into a rough apartment and costs 30-40% cheaper than at the initial assessment. All these losses are then included in the calculation of the cost of risk. All this is calculated mathematically. And if the collateral does not cover potential losses based on the history of collateral sales, then the Banks accrue reserves, in other words, they recognize potential losses already during the period when the borrower becomes problematic.
  3. Bank margin. The Bank, being a commercial organization, lays down its margin, which must cover all fixed costs and ensure the rate of return for the Bank. Now the Bank’s Margin is in the region of 4% and above, depending on the competition and the uniqueness of the product.  

Therefore, in order to reduce the cost of mortgages for borrowers, you need to reduce each of the components.  

  1. Reducing the cost of funding is possible only by reducing the risk-free funding rate, which depends on the base rate. The base rate depends on inflation in the country. Inflation depends on economic policy in general. Therefore, if we want to reduce the overall cost of funding, we need to fight inflation. I have already written many posts about inflation. Basically, it is necessary to increase supply in the country, refuse to stimulate imports through ill-conceived government programs, not stimulate consumer demand without expanding supply, and create an institutional environment to attract investment. Therefore, we want a cheap mortgage – we are fighting inflation. Funding not at market rates will only lead to higher prices for apartments and globally, most people will not pay less on mortgages.
  2. Risk reduction needs to be done in two ways. Firstly, to provide more data to STBs in order to be able to analyze the client and improve scoring models. Secondly, it is necessary to reduce the cost of collection of bad debts. To do this, it is necessary to change the laws aimed at recovery in general, to abolish recovery barriers and create a unified law enforcement practice. Many posts could be written about this. Remember that there are more good borrowers than bad ones, and it is good borrowers who pay bad ones through the interest rate. For those, who really need help, assistance mechanisms should be created through the state. Instead of subsidizing rates, it is better to create the right aid mechanisms. We need a correct, precisely correct law on the bankruptcy of individuals, which would solve the problems of everyone, who really cannot pay, and would not become a legal way to avoid obligations.  
  3. The Bank’s margin is reduced by reducing the cost of ownership of the process, in other words, it is necessary to promote the digitalization of STB. But most importantly, margins are shrinking in a competitive market. The more Banks, the lower the Margin. Unfortunately, the number of banks is only decreasing in our country.  

There is no other way to reduce the cost of a mortgage. You can artificially reduce the cost of mortgages, as is happening now, but all this is simply shifted through real estate prices.

Europe has low funding costs, low risks and high competition.  

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