“The current interest rate lows increase the risk of overestimating the possibilities for the repayment of one’s loan. This entails an additional need for safeguards in order for households to avoid unfortunate consequences,” says Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania. According to him, the aim of the projected changes is to achieve two main objectives – ensure that a borrower is ready for likely interest rate changes and to help avoid running into debt.
To mitigate the risk of over-indebtedness, the Bank of Lithuania proposes to shorten the maximum maturity of a loan from 40 to 30 years. This proposal was submitted having taken into consideration international practices and seeking to prevent the trends when, due to smaller monthly instalments, the loan maturity is extended significantly. This results in a much larger amount of interest paid by the customer. In terms of the average interest rate over the last decade, after shortening the loan maturity from 40 to 30 years, the customer’s monthly instalment would increase by roughly one tenth, however the total amount of interest paid to the credit institution would contract by even 40 percent.
Analysis of the Bank of Lithuania shows that longer loan maturity is also related to more frequent delays in paying loan instalments. In some countries, e.g., Canada, France, Portugal, Finland, Bulgaria, loan maturity is limited to 25 years.
The Bank of Lithuania is seeking to introduce responsible assessment of customer’s risk: banks should take into account likely interest rates over a long period (housing loans are extended for this period), not only those in the current period, which currently are particularly low. This would enhance debtors’ resilience to likely interest rate increases. Under the presented proposals, all credit institutions, in assessing a customer’s possibilities to pay monthly housing loan instalments, will have to apply a relevant interest rate not below 5 percent. The latter has been calculated based on the average 10 year interest rate and taking into account its volatility.
The proposed changes to the Responsible Lending Regulations would significantly reduce the risk of over-indebtedness, as the currently theoretically possible maximum ratio of the debt amount to annual income, reaching 11 times, would fall to approximately 6 times.
Other currently effective requirements of the Responsible Lending Regulations, for example, the loan-to-value ratio of 85 percent will remain unchanged.
In order to counteract the likely effects of the changes on lending volumes and provide the opportunities for banks to more flexibly consider extraordinary cases, an exception is being proposed: to one tenth of the portfolio of new housing loans extended, credit institutions might apply the loan-to-income ratio of up to 60 percent.
The changes would only apply to new housing loans; the proposed date for the changes to come into effect is 1 July 2015.
Currently the Bank of Lithuania has been consulting credit market participants regarding the changes to the Responsible Lending Regulations. Following these consultations, the proposed changes to the Responsible Lending Regulations will be discussed and approved by the Board of the Bank of Lithuania.