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The Balance Principle

There are virtually no liquidity and refinancing risks in the Danish mortgage credit system due to the balance principle and the way the Danish mortgage banks operate mortgage lending in practice – the match funding principle.

The principle establishes a close match between the bonds and the mortgage loans issued safeguarding the tight connection between the borrowers’ payments to the mortgage banks and the mortgage banks' payments to the bond owners.

An example: A mortgage bank issues and pays out a 30-year mortgage loan to the amount of DKK 1m with a 5 per cent fixed interest rate. To do this, the mortgage bank must issue and sell bonds with 30 years maturity worth DKK 1m with a 5 per cent fixed interest rate.

These transactions are called match funding. They are the foundation of transparent loan costs and market-based prices and unique prepayment options.

 

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Limited risk


While long-term fixed rate loans generally have a fixed interest rate throughout the loans’ maturity, adjustable-rate mortgage (ARM) loans have a fixed rate for 1, 3 or 5 years. These loans require refinancing every 1, 3 or 5 years. The new interest rate, which may be higher or lower than the previous interest rate, is fully transferred to the borrower. The system reduces the financial risks carried by the mortgage banks to a minimum. The only exception is if the borrower defaults on his payments.

This is the credit risk. The risk is not meant to be a burden on the bond holder. To prevent such an eventuality, the mortgage banks have a statutory obligation to hold sufficient reserves to be able to handle such situations. No bond holder has suffered financial losses in the more than 200 years of Danish mortgage credit.

Balance provides transparency
The match funding provides transparency. It allows borrowers to survey the size of their repayments, interest rate and fees and it provides bond holders with the secure knowledge that the mortgage banks and the issued bonds carry a very limited risk. The low risk on investments induces investors to reduce their demands on investment returns. In this way, the Danish mortgage credit system is designed to the advantage of the borrowers as well as the investors.

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Finance Denmark is an business association for banks, mortgage institutions, asset management, securities trading and investment funds in Denmark. Our members are mortgage institutions, banks, savings banks, cooperative savings banks, Danish branches of foreign banks, asset managers, Danish securities dealers and investment funds. 

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