The Danish mortgage model is based on the statutory framework and the way in which mortgage banks operate in practice within this framework. The most important parts of the legal framework are:
- Mortgage banks may grant loans against a mortgage on real property within a fixed lending limit (loan-to-value/LTV).
- The valuation of the real property and the calculation of the loan amount take place in compliance with a set of rules laid down by the Danish Financial Supervisory Authority, The Danish FSA.
- The loan may solely be funded through the issuance of bonds. This means that the mortgage bank cannot raise funding by deposits to fund its mortgage lending.
- The issuance of bonds by mortgage banks is subjected to the balance principle. The balance principle ensures that mortgage banks do not assume significant risks in connection with their lending activities and the funding of loans. This is true for interest rate risks, liquidity risks, currency risks etc.
- The bond holders have a preferential status in the event of a mortgage bank’s bankruptcy. However, there has been no bankruptcies in the more than 200 years of Danish mortgage credit.
- Mortgage Banking in perspective
The lending activities of the Danish mortgage banks are characterised as follows seen from the perspective of the mortgage banks and the borrowers, respectively:
The mortgage banks’ perspective
The mortgage bank only grants a loan after having received satisfactory documentation for the income and financial position of the borrower. When establishing loans, the mortgage bank will issue bonds on a daily basis to fund its lending activities (tap-issue). The interest rate on the day of issuance determines the loan’s interest rate. Thus the mortgage banks have "prime" loans in their lending portfolios.
The loans remain on the mortgage bank’s balance sheet throughout the loans’ lifetime, thus letting the mortgage bank carry the credit risk. This ensures a solid credit policy forestalling loan bubbles such as the US subprime crisis.
The mortgage bank operates with an almost perfect balance between granted loans and issued bonds, i.e., that the loans and the funding virtually mirror each other. This is called match funding.
In practice, match funded mortgage loans in conjunction with the balance principle mean that mortgage banks neither carry interest rate risks, liquidity risks nor refinancing risks in connection with granting and funding mortgage loans.
The borrowers’ perspective
Match funding loans provides full price transparency. The interest on the loan corresponds to the capital market rate. A separate fee, calculated on the basis of the remaining debt, is paid to the mortgage bank. The fee changes according to changes in market conditions.
The borrower has the unique prepayment option. There are two means of prepayment: the borrower may buy the bonds in the market and surrender them to the mortgage bank or, in the event of callable bonds, to prepay them at par, or another pre-determined price. The access to prepayment allows the borrower to plan his debt and financial risk. The borrower may adjust his financial situation in relation to both actual and anticipated developments in interest rates, just as he may plan for expected events, e.g., social events or home renovations, which may affect his financial position.