Comparison of Construction Loans in the U.S. and Germany
Most economists would agree that the success or failure of any country’s economy is largely based on the success of its mortgage and home loan market. Both the United States and Germany are currently feeling the squeeze of a declining housing loan market.
New Century Financial Corporation
The last decade has seen the sub-prime mortgage loan industry grow by an estimated 25% per year. As a result of this explosive growth, New Century Financial Corporation enjoyed a position as the second largest sub-prime mortgage lender in the United States. The past six months however have witnessed the startling and swift decline of New Century because of increasing defaults and an inability to finance their loans. The company has filed for Chapter 11 Bankruptcy, and amidst charges of criminal conduct, insider trading, and misrepresented annual statements, New Century’s stock has dropped nearly 90%.
Recent figures indicate that more than 4.6% of all sub-prime loans were currently in foreclosure compared to less than one half of one percent of prime loans. Admittedly, the sub-prime market has always been a risky venture, but, for a time, it was highly profitable. The sub-prime market’s massive and speedy growth was bound to come to an end according to some experts, and the demise of this market is straining the U.S. economy.
Sub-Prime Lending and the U.S. Economy
New Century’s downfall has started a snowball effect in the nation’s sub-prime lenders. Originally, sub-prime lending enabled individuals who would not have qualified for a prime home loan to purchase a home. Most of the targets of sub-prime loans are individuals with poor credit who are likely to have some difficulty making the loan payments. Sub-prime loans have enabled these people to purchase homes with adjustable rate mortgages with little or no money down. Predictably, according to some experts, these people have subsequently been unable to make their loan payments and are in arrears or foreclosure. Some figures indicate that almost 16% of such loans are currently in past due status.
The questionable sustainability of the sub-prime market has resulted not only the bankruptcy and foreclosure of the homeowner, but also the destruction of the lender. As the FED considers raising interest rates in the coming months, the strain on already overtaxed homebuyers is likely to increase resulting in an even higher rate of foreclosures and further sub-prime mortgage lender collapse.
The German Housing Market
Following a housing construction explosion that peaked in the early 1980’s, Germany, whose homeowner rate peaked at 66%, has experienced a marked decline in new home construction. Although Germany’s economy remains relatively strong, because that country’s housing industry results in the largest investment impact, a decline in the industry would understandably result in a weakening of the economy.
Germany housing market is at the opposite end of the economic spectrum as compared with the United States. New construction has stalled for a number of reasons including high interest rates on home loans, or “kredite”, and financing costs, massive increases in land values as well as a general decrease in the availability of land in some desirable areas, an almost 200% increase in construction prices, and the German government’s cessation of savings incentive programs that reduced construction loan costs. The number of people in Germany who would like to own homes is twice that of actual homeowners, but the costs of financing their homeownership are so high as to price many individuals out of the market.
Financing for German construction loans, or "Baufinanzierung" are increasingly harder to get than those in the United States. German lenders require a minimum of 20% of the purchase price of the home to be provided by the buyer and interest rates are often locked for more than a decade. German lenders generally will not lend on a home loan with a loan to value (LTV) rate of more than 70%, leaving many German home buyers saving for many years just to afford the down-payment on their home purchase. Additionally, the tightly locked interest rates prevent the homebuyer from refinancing and enjoying the benefits of a lower rate and therefore a lower payment. Finally, German lenders, unlike the swarm of sub-prime and what are often considered predatory lending practices of U.S. lenders, have strict guidelines regarding buyer credit rates.
Comparison of Lending Practices
Admittedly, Germany and the United States are as far apart in regard to lending practices as they are in geography. However, it is interesting to note that Germany has recently begun discussing lowering its stringent standards in order to promote more new housing construction. Currently though, Germany’s standards ensure that few homeowners default on their home loans and that only qualified buyers are eligible for home and construction loans. The situation of the United States, where sub-prime lending has led to a precarious economic position for many people and businesses must surely be a lesson in how not to handle sub-prime lending.