OREANDA-NEWS. Fitch Ratings says in a newly-published report that arrears on Dutch mortgages with a high interest-only (IO) component are 20% lower than UK IO loans.

Fitch also said that UK IO loans are 50% more likely to be in arrears than a UK repayment loans whereas in the Netherlands, mortgage loans with a high IO component perform the same as repayment loans.

This difference is mainly driven by incentives - in the Netherlands, tax incentives have made IO mortgages economically attractive for all borrowers, while UK borrowers tend to use such products to reduce their monthly instalments, attracting higher-risk borrowers.

Additionally, UK IO mortgages are not typically backed by repayment vehicles. In contrast, the vast majority of Dutch loans combine an IO loan part with a second part which amortises or to which a monitored repayment vehicle is attached, thereby reducing the bullet payment risk. Fitch calculated an 'adjusted loan to value (LTV)', assuming a partial build-up in the different repayment vehicles, and found that under adverse economic conditions, the adjusted LTV would be 33% lower at maturity.

In its report, Fitch estimated potential principal shortfalls on IO loans at maturity under different scenarios. For all scenarios, the shortfalls on Dutch loans were smaller than for UK IO loans, despite having higher LTVs. This is a direct result of the presence of linked repayment vehicles on Dutch multi-part loans, which shows that the high leverage of Dutch loans is mitigated by the attached repayment vehicles.

Owing to house price appreciation, principal shortfalls on IO loans maturing in the UK and the Netherlands prior to 2020 are expected to be limited. Long-term shortfalls will be dependent on house price movements and servicer's efforts. Borrowers with IO mortgage who reach the end of their mortgage terms , but have no means of making a bullet payment and are unable to refinance their mortgage, will be reliant on lenders offering solution to repay the loan. These could include extending the loan term, switching to a repayment mortgage or even borrowers having to downsize or sell their property to repay their mortgage.

IO lending in both countries has sharply reduced since the global credit crisis. In the UK, this has been driven by lenders tightening their criteria and regulatory emphasis on the ability of the borrower to repay the loan. In the Netherlands, tax changes have made IO loans for new borrowers less attractive to the extent hardly any new IO loans are now being underwritten. However, Dutch borrowers who already enjoy favourable tax treatment on their IO mortgages are allowed to refinance to another lender and still keep the favourable tax treatment.