Annualised average growth in the last four quarters remains in double digits but the trend is reverting: some countries, mainly the Nordics, experienced quarter-on-quarter declines in the third quarter and the trend strengthened in the last quarter of 2022.

Figure 1: Average house price growth

Source: ECB, Scope Ratings

The main culprit is clear: “housing market dynamics are very sensitive to mortgage rates”, according to a study in the ECB’s Economic Bulletin of September 2022. The study found that a one percentage point increase in mortgage rates leads to a decline of around 5% in house prices (after two years) and a drop in housing investment of 8%.

This historical trend is even stronger in a low interest-rate environment. This means we can expect a 9% drop in average values within two years because that’s where we are: mortgage rates are coming from historical lows and, according to the ECB, they increased more strongly than ever recorded in the first half of 2022.

The actual effect of mortgage rates on house prices throughout Europe is mixed, however. While Swedish State-owned mortgage lender SBAB Bank reported a market-wide transaction-based decline of 17% between the market peak of early 2022 and January 2023, prices in Spain grew by about 7.1% in 2022 according to a report by Sociedad de Tasación, the property valuation firm.

This is because the housing market is also affected by factors other than mortgage rates; structural elements within a local mortgage market, for example. And some markets are more vulnerable to rising rates than others. Key drivers here are above-average household debt, floating interest rates and unsustainable house-price growth over the last decade.

Scope’s heat map suggest Norway and Sweden most exposed

Combining these drivers, Norway, Sweden and Luxembourg show the highest structural vulnerability to mortgage risks arising from affordability shocks and value declines. To some extent, this risk has already materialised. Denmark, the Netherlands and Portugal also show higher structural risks compared to other European countries.

The Euro Area periphery (Spain, Italy and Greece), which have only slowly recovered from the very high value corrections during the GFC, show relatively strong metrics. The housing sector in Eastern Europe is showing moderate structural risks. This is mainly driven by moderate household indebtedness despite some unsustainable growth observed.

Figure 2: Heat map structural risks to residential mortgage

Source: Scope Ratings

Pressure highest in active mortgage markets

Europe’s mortgage market is very diverse. Most households in Eastern and Southern Europe own property but without a mortgage attached. This contrasts with Northern European countries such as Norway, Netherlands Sweden and Denmark, where more than 75% of owner occupiers have encumbered property.

As a consequence, households in these countries have also the highest indebtedness in Europe. But even here the picture is mixed. While Danish and Dutch households where able to reduce their debt-to-income profile in the last decade in line with the European average, Norwegians became even more leveraged.

Looking into origination of new European housing loans, only 16% were in the form of floating-rate loans in 2022. The remainder have reset periods at least every year – in most cases fixings are every five to 15 years. That means rate increases to levels seen last in 2013 will only hit a minority immediately. This is reassuring, taking into account that core inflation is putting extra pressure on European households.

In that respect, it is good to see that most European mortgage markets took advantage of the ultra-low interest-rate environment to switch into a longer reset products, as evidenced by the fact that the aggregate percentage of floating-rate mortgages has halved in the last 10 years.

But speaking to the diversity of housing finance in Europe, the share of floating-rate loans even increased in some countries in the last decade. This chiefly concerns the Nordics, which continue to be floating-rate mortgage markets and where fixed-rate loans are a niche product.

Consequently, among the four countries most exposed to a combination of high indebtedness and floating interest rates, three are Nordics. Denmark is not part of this group: the country has historically had the highest household indebtedness but otherwise benefits from a relative low share of floating-rate loans.

The extent to which house prices are subject to a revaluation also depends on their relative long-term economic growth. Comparing average annual house-price growth since 2010 against long-term GDP growth, Sweden and Norway remain elevated. Growth is well above sustainable levels in Austria, Luxembourg and Norway where annual house prices often increased in double digits compared to a very moderate average nominal GDP growth. Growth in Denmark and even more so Finland is relatively sustainable.

Moderate risk in UK and Switzerland

While some data constraints limit this analysis to the EU; the UK and Switzerland are not exempt from mortgage risks. Both show moderate exposure to strong value depreciation. Even though Switzerland ranks top 3 on household indebtedness, it has a very low owner occupancy of only 42%. At the same time, most mortgages are fixed rate so do not expose households to immediate affordability shocks. Finally, long-term house-price increases were moderate at around 3% and well in line with GDP growth.

UK’s household debt is moderate. Also, roughly three quarters of UK mortgages are fixed rate and almost all new mortgages taken out since 2019 have been fixed-rate, albeit with mainly two or five-year fixes. However, the long-term increase in house prices was around 6%, more than double GDP growth over the same period.

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