Signs of overheating in the real estate market could lead the central bank to review the requirements for issuing housing loans
The latest Financial Stability Review by Eesti Pank notes that there is a lot of activity in the Estonian housing market, unlike during a typical crisis. Developers have fewer new apartments on offer than usual, and so people wanting to invest in real estate using the savings they have built up during the pandemic and the money that will be released from the second pension pillar in the autumn may lead to real estate market to overheat. If real estate prices and household debt levels should start to rise very rapidly, the central bank is ready to tighten the requirements on issuing housing loans.
In the assessment of Eesti Pank, the risks to the functioning of the financial sector are large, but companies and people have so far managed their financial obligations well. The risk to financial stability is reduced by a strong banking sector that is well capitalised and profitable. This makes banks better able to cope with loan losses and has allowed them to continue lending to companies and households during the pandemic. It is still possible though that the spread of the virus will not cease and that the restrictions will have to remain in place for longer, in which case several major sectors of the economy could face difficulties. Eesti Pank finds that the banks would be able to support companies and households even in a much more negative economic scenario than that which is currently foreseen.
The real estate market has been very active despite the crisis because the interest in buying has been supported by wage rises in most sectors of the economy and by rapid growth in household deposits. Eesti Pank does not currently see any major problems in the real estate market, but looking forward the risks will increase of real estate prices starting to rise fast. Prices may rise rapidly because of a combination of factors, as Covid-19 is being brought under control and the restrictions removed, people feel increasingly confident, borrowing is cheap because of the monetary policy of the central banks, the banks want to lend on good terms, and more than a billion euros will be taken out of the second pension pillar in the autumn.
If a large part of the money that is taken out of the second pillar is used to make larger down payments on housing loans than previously, it would amplify further the investment in real estate made with borrowed money. If there is a real estate boom, people may not accurately estimate their ability to service their loans or the real value of their investment. There was a similar real estate boom in Estonia about 15 years ago, when a price bubble expanded in the real estate market and household debt increased dramatically.
If real estate prices should start to rise very rapidly and household debt levels do so together with them, Eesti Pank is ready to tighten the requirements on issuing housing loans. Eesti Pank has set requirements that are designed to prevent a lending boom and protect households and borrowers from taking on too much risk. The current Eesti Pank rules allow loans to be issued for up to 85% of the value of the real estate backing the loan, while the loan repayments may not exceed 50% of the income of the borrower.
If the loan is guaranteed by KredEx though, the banks may exceptionally lend up to 90% of the value of the real estate used as collateral. There has been a substantial increase in the past year in the use of KredEx guarantees to reduce down payments. In spring last year, 12% of new housing loans by volume used KredEx guarantees to reduce the down payment below 15%, while in spring this year 18% did. If this increased use of guarantees causes demand for real estate to grow substantially, and with it prices, then housing actually becomes less accessible. The central bank considers that there should be a thorough assessment of how broadly the state provides guarantees through KredEx.