Mortgage interest rates

inSight

27 Nov 2003

Mortgage interest rates

A number of factors are behind the present very low mortgage interest rates in Hong Kong.

I am sure readers, particularly those making mortgage payments every month, are aware of the extent to which mortgage interest rates have come down in the past five to six years. In early 1998, when the mortgage interest rate peaked, made possible by the reversal in interest rate trends for the US dollar, Hong Kong dollar mortgage interest rates charged by banks were around 11.5%. After falling continuously for almost six years, the mortgage interest rate offered in the market now is around 2.375%. And there have been a variety of benefits offered to borrowers, including cash rebates, subsidies for legal fees and renovation expenses.

The favourable trend in US dollar interest rates, which has been fully reflected in Hong Kong dollar interest rates because of the Linked Exchange Rate, is of course the main reason for the fall in mortgage interest rates in Hong Kong in the past six years. Our monetary policy of maintaining a fixed exchange rate has therefore worked to the benefit of all those servicing mortgages. Confidence in this policy, notwithstanding a rather difficult period, has helpfully contained the size of the interest rate premium of the Hong Kong dollar over the US dollar, making it possible for the public to benefit fully from the favourable trend of declining US interest rates. This illustrates how important it is to sustain public confidence in the Link, something I hope has been derived from the transparent and professional manner in which we manage the monetary system.

The fall in mortgage interest rates has in fact been significantly larger than that made possible by the fall in US interest rates. In early 1998 the mortgage rate was priced at prime plus 1.25%. Now it is priced at around prime minus 2.625%. The mortgage rate is therefore 3.875 percentage points lower as a result of the change in pricing practice of the banks. This, of course, is a welcome change, from the point of view of those paying mortgages, and not only new ones but also existing ones, given the willingness of the banks also to adjust the terms of existing mortgages correspondingly.

The reasons for this welcome change, however, may not have been widely understood. It will be useful to look into them. One that comes to mind readily is greater competition. This indeed is the case, and is the result of a number of initiatives specifically to increase competitiveness in the banking system. There was first the elimination of the Interest Rate Rules of the Hong Kong Association of Banks, which freed up the determination of deposit interest rates and increased competition among the banks. Then there were the measures taken to relax the market entry criteria, including the lowering of the asset and deposit size thresholds, and the shortening of the qualifying period for the upgrading of authorized institutions to licensed bank status from the other two tiers.

Significant changes in the mortgage finance market also contributed to producing much more competitive mortgage interest rates. There were two notable changes. One was the cyclical downturn in the residential property market. The bursting of the property price bubble dampened considerably the demand for mortgage finance. With the general demand for credit also remaining subdued as a result of the slow economy, there was a surplus of liquidity among the banks, resulting in much more competitive pricing for such traditionally good quality assets as home mortgages. This is notwithstanding the large erosion in the value of the security of the loans, evidenced in the large fall in property prices of over 60% over the past six years. The low delinquency ratio of residential mortgages provided much comfort to the banks.

The second was the structural change in the market. This tends to be overlooked. There has been a significant improvement in the condition in which the banks can manage the risks of their mortgage business cost-effectively. This was made possible by the establishment of the Hong Kong Mortgage Corporation (HKMC) in 1997. Since then, banks have been able to manage the risk of their mortgage portfolio, if necessary, through offloading part of it to the HKMC. Banks may also choose to repackage part of their mortgage portfolios into back-to-back mortgage-backed securities with the HKMC providing a guarantee on timely repayment to remove the credit risk of the securitised portfolios. This process will be greatly facilitated by the model mortgage origination documents to be launched by the HKMC today. This indirectly led to a much more elastic supply of mortgage financing and hence more competitive pricing. The HKMC has been in operation for six years. This period coincides with a period in which the differential between the mortgage interest rate and the best lending rate changed from a premium into a discount - a fall, as I mentioned earlier, of 3.875 percentage points. But this is more than a coincidence. The HKMC has played a significant role in bringing about more competitive mortgage interest rates.

 

Joseph Yam

27 November 2003

 

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