Mortgages: is there life after July 1?

MORTGAGE LENDING MARKET TRENDS

• The Bank of Russia is gradually reaching its goal to systematically cool the mortgage market. The expected significant decline in mortgage issuances in July 2024 does not look dramatic if compared to the same periods of different earlier years, and not the record-breaking 2023. In addition, it took at least half a month to approve new terms of preferential programs and for banks to adapt to them and the stricter regulatory requirements.

• ACRA expects the mortgage portfolio to grow by 10–15% in 2024, while the total size of mortgage issuances should be RUB 5–5.2 tln, which is approximately 35% lower than the record year of 2023 (RUB 7.8 tln), but still a little (+5%) higher than in 2022 (RUB 4.8 tln). The decline in mortgages provided for primary market housing may amount to around 25%, while for other mortgages this figure will be 40%.

• The question of whether a bubble has formed in the mortgage market is still relevant because the price of a square meter of housing grew much faster than the population’s income in 2020–2024, but at the same time the quality of the mortgage portfolio remains stable (the share of non-performing debt was 0.6% as of July 1, 2024).

• Residential real estate prices are generally stable now, however, over the next 12 months, ACRA assumes the possibility of a slight correction within 3–5% both in the primary market and the secondary market, after which the price of housing will again start to grow over a horizon of more than 12–18 months. Confident growth of funds of the population held in bank accounts may partly be due to deferred demand for residential real estate, the realization of which may begin no earlier than Q3 2025. As the list of assets for investment and saving is very limited, a significant portion of the population’s funds will most likely flow back into the real estate market.

• Early repayment of mortgages does not make economic sense against the backdrop of rising deposit rates, which carries the risk of deterioration of the quality of bank portfolios in the future. Given the large share of preferential programs in banks’ mortgage portfolios and the significantly increased average term of mortgage loans (increased from 18 to 26 years since spring 2020), the average lifespan of mortgage loans, ACRA assumes, will be at least 10 years in the short term.

• The mortgage standard, which comes into force in early 2025 and was developed to protect the rights and legitimate interests of borrowers, may lead to an even greater increase in the mortgage rate, since banks will most likely begin to include in it the benefit lost due to the effect of this standard.

IS EVERYTHING REALLY THAT BAD?

The volume of mortgage loans has noticeably decreased after the termination of the Preferential Mortgage¹, changes to the conditions of a number of other preferential programs for primary housing (including making them more targeted and increasing rates), and the tightening of macroprudential requirements by the Bank of Russia in July 2024. Banks and developers have begun to sound the alarm about the sharp decline in the mortgage market.

Indeed, if we compare it with the boom month of June this year (when the population wanted to catch the last carriage of the departing train, by taking out a mortgage with state support at 8% before June 30, 2024) — then the decline is obvious: 75%. At the same time, if we compare it to the record figures of July 2023, then the decrease was 53% in million rubles of issues and 60% in loan issuances, while compared to July 2022 it is already less — 26% and 22%, respectively.

However, one should not underestimate the factor of the number of days the family mortgage was valid in July 2024: no loans were issued under the program during the first 10 days of the month due to the lack of approved adjusted terms for it, and it took several more days for banks to adapt internal processes to changes in the programs. So, if this gap had not existed, then (when adjusted to the month), compared to July 2023, the decrease could have been 6% in million rubles of loans issued and 19% in loan issuances, and compared to July 2022, an increase of 48% and 56%, respectively, would have been recorded.

¹ Resolution of the Government of the Russian Federation dated May 2, 2024 No. 24-22-67374-00473-R “On the provision of subsidies”.

In this regard, it is more possible to speak of a slowdown in the growth rate of mortgage issuances compared to the record year of 2023, which correlates with the Bank of Russia’s goal of consistently cooling the market. Moreover, compared to 2022, issuances in 2024 no longer look frightening, but, on the contrary, may confirm the advisability of the continued tightening of requirements by the regulator.

The Bank of Russia’s data for August this year evidences that the mortgage market has adapted to the current situation. Compared to July, issuances grew slightly (+5%), mainly due to mortgages for primary housing. Furthermore, according to information from the banking community, the market recovery continued in September. This is achieved, among other things, due to the fact that banks and developers are still developing and using tools to support issuance/sales, and borrowers are afraid of exhausting their family mortgage limits and further increases in market rates.

In addition, the population’s demand for preferential mortgages, mainly the family program, remains high (according to the Bank of Russia, this program’s share out of all preferential programs in August and September amounted to around 90% and just over half of all provided mortgages). Demand is confirmed by the rapid exhaustion of limits for current programs and is stimulated by the significant difference between preferential and market rates. As the Bank of Russia’s key rate continues to rise, this delta will only increase, meaning that the population will be more inclined to take out loans at non-market rates and deposit free funds (if any) in banks at high interest rates.

Currently the expectations of ACRA and a number of banks (the leaders of mortgage lending) in terms of the total volumes of issuances to obtain primary and secondary residential real estate this year are very close — RUB 5–5.2 tln, which is roughly 35% lower than the figure for the record year of 2023 (RUB 7.8 tln), but still a bit higher (+5%) than 2022 (RUB 4.8 tln). At the same time, the Agency expects issuances of mortgage loans for new buildings may decline by around 25% this year, while other mortgages will fall by 40%.

what about prices?

Currently, residential property prices are generally stable, indicating some stagnation and at the same time a possible correction in the short term. In addition, both developers and owners of secondary housing are increasingly willing to accept a discount.

Several factors are holding back a possible correction in the cost of primary housing:

• The significant difference between preferential and market rates, which currently average 18–20%, helps maintain demand for primary housing by extending the validity periods of preferential programs;

• Different offers from developers, mainly those based on formally more beneficial conditions for buyers (including deferred payment programs, partner programs with individual banks, and low rates over several years at the same time as a higher real estate purchase price);

• The short period of time that has passed since the termination and/or change in the terms of a number of preferential programs: that is, prices have probably only just begun to slow down and are still growing by inertia, albeit slightly.

Prices for secondary real estate are being supported by the comparatively low cost of these properties compared to primary market housing. According to the regulator, the cost of a square meter of primary real estate differs from secondary real estate by 55%. This difference has formed not only due to objective market reasons, including due to the increase in construction costs, but also artificially — in connection with the designation of the end dates of preferential programs, as well as the placement of apartments in small batches for open sale by developers. This motivated people to prioritize buying real estate and several times led to spikes in price growth from 2020 to 2024.

The stability of prices for secondary real estate is also facilitated by the following factors, which are not sensitive to changes in rates:

• The fact that buyers do not need to incur additional costs for renovation and furniture (unlike when purchasing primary market real estate), which is especially important in the conditions of rapid growth of housing prices;

• The need for urgent improvement of housing conditions among a certain part of the population (while the continuing increase in market rates only encourages citizens not to delay solving this problem);

• Transformation of the secondary housing market associated with the conclusion of a significant number of transactions without the use of credit funds.

The possibility of refinancing mortgages in the medium term at lower interest rates in the event of a reduction in the key rate also supports the population’s demand for real estate loans issued at market rates.

In terms of housing prices, we see some signs of a price bubble on the market as in 2020–2024 the growth rate of the price per square meter overtook that of personal incomes by far. Currently, the price per square meter in the primary market is several times higher than the average wage, which lags behind price increases. In order to avoid such a significant excess, it would be advisable to build more residential real estate and, make housing more affordable, and prevent developers from forming an artificial shortage of apartments for sale. Developers’ profits could obviously suffer from this, but the same amount of profits can be earned due to economies of scale. Taking into account the described factors, the question of the existence of a mortgage bubble is still relevant.

For details, see ACRA’s forecast Warm, Hot, Colder from August 1, 2024.

and what about quality?

The stable quality of the mortgage portfolio, on the contrary, indicates the absence of a bubble in the mortgage market at the moment. The share of non-performing debt in the portfolio remains low — 0.6% as of July 1, 2024 (according to the Bank of Russia, these are loans of IV–V quality categories, i.e., non-performing and bad loans). Although the growth of delinquencies in some Russian regions has been accelerating in recent months, the share of these delinquencies remains low at the national scale, and mortgages are still considered one of the lowest-risk banking products.

The longer the mortgage life, the higher the probability of default due to changes in the borrower’s circumstances. Due to the large share of preferential programs in the mortgage portfolios of banks, as well as the significantly increased average life of mortgage loans (since the beginning of mass preferential programs, that is, since the spring 2020, it has increased from 18 to 26 years), the average life of mortgage loans, in ACRA’s opinion, will be at least 10 years in the near future. The economic sense of early repayment will return as soon as the average interest rates on deposits and accounts become lower than the average mortgage rate. However, there has only been a slowdown in the pace of early repayments so far, which further creates risks of accumulation of problem debt on banks’ balance sheets.

Figure 2. Early repayment of mortgages has no economic sense

Sources: Bank of Russia, ACRA

The quality of the mortgage portfolio, which is currently stable, ensures low pressure on the banking sector’s capital. In addition to extended life of mortgage loans, the main negative factor could be a significant (more than 20%) decrease in the price of residential real estate, however, this situation is not profitable for banks, developers, property owners, or the government. Some credit institutions may of course experience more noticeable stress compared to the average market stress if they applied easier mortgage lending standards in the past and maintain an insignificant capital reserve. At the same time, the level of the initial payment largely protects banks from a fall in the collateral value of real estate. In addition, higher macroprudential add-ons are also aimed at maintaining the financial stability of banks.

The Bank of Russia continues to struggle for a consistent cooling of the mortgage market, preventing the growth of the population’s indebtedness. According to the regulator, the number of mortgage borrowers with at least one consumer or car loan increased from 4.5 mln as of July 1, 2022 to 6.5 mln as of July 1, 2024, which is up to 60% of all mortgage borrowers. In this regard, tighter regulatory requirements contribute to, among other things, a structural change in the customer base of banks. Thus, the change in mortgage terms and conditions regarding the amount of the initial payment and the debt burden indicator curbs the range of potential borrowers: a mortgage is now affordable to relatively more affluent customers who have sufficient funds for the initial payment while their debt on other loans is insignificant or absent.

Meanwhile, the impact of the key rate hikes by the Bank of Russia on the total lending volume is weaker that the impact of stricter macroprudential standards that look more effective in terms of curbing the growth of new loans (especially under preferential programs). In addition, the Bank of Russia has developed a mortgage standard (based, among other things, on statistics of complaints received by the regulator), which will enter into force in the beginning of 2025 and whose purpose is to protect mortgage borrowers. However, banks are likely to factor in the profit lost due to this standard in loan interest, and therefore rates will grow even higher.

SO WHAT’S NEXT?

In December 2023, ACRA predicted the growth of the mortgage portfolio in the range of 10–15% in 2024; now the indicator has been updated to 10.5–12.5%. At the same time, in the next 12 months, the Agency allows for a price correction in both the primary and secondary real estate markets in the range of 3–5%. However, on the horizon of more than 12–18 months, the residential real estate prices may resume growing.

The current situation in the Russian banking sector is characterized by a steady increase in the volume of funds held by individuals in current and savings accounts and deposits, on the back of the ongoing key rate hikes. Individuals’ deposits and accounts, excluding escrow accounts, increased by 14% or RUB 6.3 tln in eight months of 2024, whereas for the whole 2023 the growth amounted to 23% or RUB 8.3 tln. The trend will most likely continue in 2025.

In ACRA’s opinion, such an inflow of funds may partly be explained by the formation of deferred demand for residential real estate. The accumulation of impressive resources is like a tightening bowstring. In the event of steady key rate cuts, individuals will start looking for other ways to invest their accumulated funds; according to the Agency’s expectations, this will happen no earlier than Q3 2025.

Given that the range of investment-grade assets and assets acceptable for saving money is very limited, a significant share of individuals’ funds is likely to flow back into the real estate market. On the backdrop of slowing growth of construction volumes in 2025, developers’ supply will also be limited, while the demand will remain strong due to the availability of existing preferential programs. In this case, ACRA expects a further increase in prices for new real estate. Due to the abovementioned reasons that support prices for secondary market housing, as well as the preservation of a significant difference between the cost of primary and secondary real estate, prices for secondary real estate will also resume active growth.