Finnish housing companies are taking on bigger loans, adding risk to the housing market despite regulatory measures to curb indebtedness among homebuyers. Homebuyers now have to stump up a 15-percent deposit to fund their property purchases, but investors face no such restrictions—and are even eligible for tax breaks that encourage this type of debt.
Juhana Brotherus, an economist from the mortgage lender Hypo, says that regulation would be the most effective way to curb risk in the housing market, and such regulation should focus on investors.
"We have seen the regulator increase the loan-to-value ratio requirements for owner-occupiers, but that isn't where the greatest risk lies," noted Brotherus.
The issue hinges on the Finnish system of housing companies, which own and run most apartment blocks and property developments in the country. Homeowners buy shares in the company, allowing them to use their own flat, but they pool the risk related to structural repairs and maintenance with all the other homeowners who are members of the housing company.
Those companies are increasingly indebted, with new housing companies leading the change toward bigger loans. Many new apartments in Finland's bigger cities can now be purchased with just a modest upfront payment representing just a small portion of the home's nominal value.
Tax breaks for investors
The rest of the purchase price is subsumed into debt taken on by the housing company, for which the owners remain responsible.
Brotherus says this pooled debt is now rising faster than many homeowners realise. For example if an investor owns several flats in a building and then is unable to pay their share of the housing company loans, the other homeowners in the same building become responsible for the the repayments.
Likewise, some buyers may be unaware of the lengthy interest-only payment periods on housing company loans, which give an unrealistic picture of the monthly costs of ownership in the first years after the home is built. Once capital repayments kick in, some investors and homeowners alike could find themselves struggling to make the payments.
According to calculations from Brotherus, housing company debt can also save investors thousands of euros a year in tax payments—a tax break unavailable to owner-occupiers.
For an example property costing 400,000 euros to buy debt-free, the purchase price could be just 100,000 euros. The remaining 300,000 euros would the investor's share of the housing company's debt. If the investor rented out the property at 1,600 euros per month, he could then deduct 300 euros a month from capital gains tax due on the rental income.
This tax break adds up to thousands of euros over the lifetime of the loans, although capital gains tax is eventually due if the investor decides to sell the property. Crucially, the tax break is not available to investors who decide to pay off their share of the housing company loan by borrowing the money personally.
Lenders treat housing company debt differently to home loan debt taken on by the homeowner, with the former typically attracting slightly higher interest rates. However those rates are not usually as high as interest levied on investors if they borrow the money for the purchase themselves.
Senior Statistician Atro Andersson of Statistics Finland says in a blog post that the number of heavily-indebted housing companies has increased markedly since 2010.
In Oulu, Tampere and Turku more than half of all new-build apartments are structured in this way, with more than 70 percent of the home's value held as debt taken on by the housing company. A decade ago just one in ten new apartments built in Tampere carried this much debt.
Just 13 percent of new apartments sold last year did not have any housing company debt attached to the property.
The shift towards housing company debt is driven by investors, according to Brotherus. He says that an investor buying a home loaded with housing company debt can save money and take advantage of tax breaks—but the practice increases risk for the housing company and the lender.
Regulation "could help"
"We are a prudent lender, so when we lend to housing companies we go through the books quite carefully," Brotherus told Yle News. "If we find a lot of the shares are owned by investors and the debt level is relatively high, the terms of the loan are worse."
Brotherus says regulation would be the most effective way to curb risk in the housing market, adding that any such regulation should focus on investors.
Instead he suggests stipulating that capital on housing company loans be amortised throughout the full term of the loan, rather than allowing several years of interest-only payments at the start as is currently the case.
Another option would be a loan-to-value ratio limit for investors, preventing them from borrowing more than a certain percentage of a property's value to fund its purchase.
Sampo Alhonsuo, chief analyst at the Finnish Financial Supervisory Authority, says that the organisation has been mostly concerned with rising household indebtedness in recent years, noting that even in 2009 and 2013-14, when Finland’s economy contracted, household indebtedness still rose.
In the housing market the FSA has already used the one weapon (or 'macroprudential measure' in the jargon of financial regulators) in its arsenal to curb debt accumulation--the aforementioned rule demanding more collateral for housing loans--and has no influence on tax breaks.
The FSA man says there are some gaps and drawbacks in the data regarding household debt and housing market in general, but on tax rules for investors encouraging riskier debt he says the ‘logic is correct’--although it's impossible to tell in advance whether or not risks will be realised.
“It’s part of our job to consider what kind of macro-prudential measures we actually need, and we need a couple of new ones,” said Alhonsuo.