19 MARTINDALE CENTER FOR THE STUDY OF PRIVATE ENTERPRISE Indebtedness and the current macroeconomic situation The stability, affordability, safety, and transparency of the Danish mortgage system are rightfully admired on a global scale. However, this success comes at a cost: remarkable overindebtedness. Danish households have the largest debt-to-income ratio of any European country, at 2.5. The European average is less than 1. Residential mortgages account for 82% of all household debt in Denmark, making the fluctuations of interest rates, debt servicing costs, and the mortgage market massively influential to the health of the Danish consumer (Scope, 2021). As of 2020, an average of 26.4% of a Dane’s disposable income was spent on debt servicing costs, the third highest value in the EU trailing only Greece with 36.6% and Germany (Europe’s largest covered bond market) at 29.7% (Eurostat, 2020). These metrics correspond to the average Danish household, yet over 350,000 (10%) homeowners spend more than a third of their income servicing their debt (Bech et al., 2021). In addition to the features that promote high leverage, accommodating tax laws also encourage high household debt. Approximately 33% of mortgage payments under 50,000kr and 25% of payments above this are tax deductible. Other sizable, covered bond markets such as Germany, Ireland, Spain, and the UK have no mortgage interest deductibility (MID). Furthermore, capital gains on owner-occupied dwellings are tax exempt. In Germany and Spain, capital gains taxes on the transfer of assets reach up to 25% (PwC, 2023). These policies, in addition to nearly a decade of low interest rates, incentivize borrowing by simultaneously reducing its costs and increasing the rewards of leverage (IMF, 2021). The startling degree of Danish leverage is important given recent macroeconomic and monetary policy developments in the Eurozone. Inflation in the EU reached 10.7% in October 2022, an all-time high more than five times the European Central Bank (ECB) medium-term target rate of 2% (Amaro, 2022). Denmark posted a 10.1% year-over-year inflation rate in October, a four-decade high (Wienberg, 2022). Due to high food and energy prices and lingering supply chain delays, the IMF expects global prices to remain high (Kammer, 2022). To dampen inflation among member states, the ECB has raised rates to 2.5% as of January 2023, the highest since 2009. Given the unprecedented scope of the issue, ECB rates will continue to rise with another 0.5% hike planned for March 2023 (Reid, 2023). ECB policy moves have strong implications on Danish monetary policy. Since 1982, the DNB has utilized a fixed exchange rate strategy, a policy framework whose sole goal is to keep the Danish krone in a stable relationship to the euro (DNB, n.d.). In theory, an increase in the ECB benchmark inflation rate will cause the euro to appreciate, a product of the increased return investors would be able to earn by storing money in the associated financial system. To keep the exchange rate stable, the DNB must increase their own benchmark rate to appreciate the krone to levels within a set range or currency band in relation to the euro. The current situation has matched theory closely as the DNB has increased rates to 2.1% as of February of 2023, the highest level since 2009 (Skydsgaard, 2023). The implications of rising rates on Danish borrowers To fully understand the consequences of rising interest rates, the DNB conducted a sensitivity analysis in 2021 to explore the impact a 1% increase in rates would have on Danish borrowers’ income (defined as the debt service–to–income [DSTI] ratio) and balance sheets (defined as the debt-to-assets ratio). While most Danes would experience a modest worsening of their cash flows and balance sheets, groups of borrowers with ARM mortgages, low net wealth, low income, limited savings, or riskier housing assets would be severely exposed to DNB policy changes (Bech et al., 2021). A 1% increase in interest rates is estimated to result in a $1750 increase in average annual debt servicing costs for Danish households. From a cash flow perspective, they found that most households were minimally exposed to rate hikes, with this increase in annual cost resulting in a negligible increase in spending for approximately a third of their 1.3-million-person sample. However, over 100,000 households in the sample had a cash flow sensitivity more than seven-times greater than the median level. Households with FRMs were naturally least sensitive to rate movements, whereas those with interest-only ARMs were most sensitive from a cash flow perspective. Households with low to negative net wealth, lower income, and lower-than-median savings had higher than average cash flow sensitivities. Considering that highly indebted households are more likely to choose IOMs due to their initially lower costs, these sensitivities frequently overlap (Bech et al., 2021). Overall, a 1% rate hike will cause 25% of households to spend an additional 5.5% of their after-tax income on debt servicing costs. Nearly 10% of households—350,000 families—will be forced to spend an extra 14.5% of their income on servicing debt (DNB, 2021).
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