European Supplement

The Spanish mortgage market

European supplement

The modern Spanish mortgage market has its origins in Law 2/1981, which entered into force in March 1981 and was further developed by Royal Decree 685/1982 in 1982. Before Law 2/1981 only public banks and saving banks (cajas de ahorros – which pursuant to their statutes were regional institutions) were allowed to offer mortgage loans to individuals. This situation limited de facto competitiveness and the creation of a true market. The new law permitted private banks and cooperatives to enter the market and mortgage credit societies were set up as sole-purpose institutions, thereby allowing the development of a highly competitive mortgage market.

Twenty-six years on

Since 1981, total mortgage lending outstanding has experienced high and continuous growth, accelerating strongly from 1995 onwards. Over the past two decades it grew from representing €12,921 million to around €900 billion, and the number of new mortgages subscribed each year rose from 135,000 to close to 1,700,000 (both residential and commercial lending). Mortgage debt as a proportion of GDP, which in the early 1980s was close to 12 per cent, stood above 90 per cent in 2006.

The strong growth in mortgage credit was driven by two key factors:

• The increase in the number of mortgage lenders after Law 2/1981 entered into force. This law allowed universal banks and other specialised credit institutions to enter the market and to compete with public mortgage banks and savings banks, which before then were the only mortgage lenders. International analysts widely viewed this increased competition as what made the Spanish mortgage system one of the most efficient in Europe.
• The evolution of interest rates. During that period, mortgage rates in Spain not only fell significantly but probably did so by more than in any other European country. This widespread fall of interest rates (from 18 per cent to around 3.5 per cent in 2005) together with the extension of the standard loan maturity for first-time buyers (from 10 years in 1981 to 27 years today) has enabled a substantial reduction of monthly instalments. Against this especially favourable background, the creditworthiness of citizens has been duplicated five times.

Current and projected performance

The strength of the economy and of the domestic real estate market has enabled the Spanish mortgage market to continue expanding. In December 2006, year-on-year growth of total mortgage lending outstanding was 23.3 per cent, and the increase in net lending during the whole year was around 14 per cent.

However, more moderate mortgage market growth was in evidence during the course of 2006, with the number of mortgages granted falling from 1.7 million in 2005 to 1.6 million in 2006. Also, with regard to house price growth, 2006 saw a continuation of the decreasing rates of growth in house prices, with the seventh consecutive quarterly fall in house price growth registered in the fourth quarter of 2006.

For the next year, most analysts are forecasting an extension of the current situation with regard to continuing falling growth in house prices (annual growth rates remaining below two digits). In addition, mortgage rates on new contracts are expected to increase quite considerably (from average rates of 4 per cent in 2006 to 5 per cent this year). Against this background, while it is expected that the Spanish mortgage market will continue its good performance, and that it will continue to meet the funding needs of the potential demand for housing, more restrained growth rates should result from a stabilisation of the residential demand.

By the end of 2007, growth rates of total mortgage lending outstanding are likely to be between 14 and 18 per cent.

Legislative improvements

Cost-efficiency has also improved over the years in the Spanish mortgage market, as attested to in the 2003 Mercer Oliver Wyman study Financial Integration of European Mortgage Markets, and its recent 2006 update.

However, a number of international analysts, including Mercer Oliver Wyman, point out that one negative element of the Spanish mortgage market is its excessively rigid legislation, which prevents the development of new products. Such legislation, together specifically with prepayment penalty regulation, has led the mortgage credit market to be composed almost entirely of one-year Euribor referenced loans.

Although the extraordinary growth of the Spanish mortgage market occurred in the framework of the current mortgage legislation, it is also true that, in the current context of a cycle change expected to bring about a more stable mortgage market in the future, the weak points of this legislation need to be removed. This would allow both control of some of the inherent risks of the currently high volatility and an increase in the range of products and borrowers on the market.

Against this background, the government is working on a modernisation law for the Spanish mortgage market, expected to be passed in 2007. The aims of the new law are:

• To expand and improve the transparency regime in the subscription of mortgage loans. This would allow Spanish credit institutions to adopt the Code of Conduct and also to provide regulation for mortgage brokers and intermediaries.
• To promote a wider range of mortgage products by removing the existing legal barriers.
• To update regulation on different mortgage funding instruments.
• To modify notary and registration fees in the operations novación and subrogación of mortgage loans. This would foster negotiation and refinancing between credit institutions and consumers.
• To allow the development of equity withdrawal and equity release, in the latter case by introducing a new regulation on reverse mortgages.

The passing of this draft law could mean the start of a new phase for the Spanish mortgage market.