The High Debt Burden of Households, a Potential Risk for Luxembourg?

In September 2017, two ratings agencies, Standard & Poor’s (S&P) and DBRS, confirmed Luxembourg’s AAA credit rating and assigned the country a stable outlook; as reported by the two agencies, the key factors that justify maintaining the highest possible rating are the Grand Duchy’s sound public finances, its solid institutions and political environment, its wealthy and advanced economy and its strong external position.

Despite these strengths, the country has to face some problems: the limited degree of its economic diversification, its vulnerability to external shocks, changes to financial regulations and international taxation and – last but not least – rising pressures on the housing market.

Residential property prices in Luxembourg have risen steadily since 2010 and this overall increase of prices had an impact on the household debt ratio. A working paper from BCL (Banque Centrale du Luxembourg) published on 4 September 2017 calculated the share of households that are financially vulnerable using survey data collected in 2010 and 2014 and concluded that, although the share of indebted households fell from 58.4% in 2010 to 54.6% in 2014, on average the households that were indebted in 2014 carried a heavier debt burden, mainly reflecting larger mortgage loans on the main residence.

In addition to the growing number of large loans in relation to the value of the property, the country suffers from a structural imbalance between a strong demand for real estate and supply-side constraints, revealed the European System Risk Board (ESRB) in a report on the “Vulnerabilities in the EU residential real estate sector” (November 2016). The results of our latest study on homes and mortgages supports this view: respondents in Luxembourg, together with the UK (49%), were amongst the countries where a largest population group believes that housing is in the wrong track.

This result is not surprising as almost everyone in Luxembourg (92%) believes prices are high where they live and they (86%) expect prices to continue rising over the next 12 months. And is not just wishful thinking on the part of property owners: the latest bulletin of the Housing Observatory in Luxembourg shows that the announced price indicators in the second quarter of 2017 have increased over a one-year period by 8% for houses and by 4.3% for apartments. The exceptional population growth over the years and the new socio-demographic trends – more and more residents in Luxembourg live alone – suggest that the increase in property prices will continue in the future.

In the short-term, household debt remains manageable below 60% of GDP and the debt service-to-income ratio appears robust, said the ratings agency DBRS. But a prolonged period of housing prices increasing more than income can constitute in the medium- or long-term a vector that weakens the financial situation of the households: what would happen if the interest rates raised over the coming months and years? Monthly payments for variable rate mortgages would increase as well and be likely to affect the solvency of part of Luxembourg’s households.

So if you intend to buy a house or an apartment in the near future, make sure you gather as much information as you can and ask for advice from professionals to understand the housing market in Luxembourg and make the right decision for your financial situation, now and in the future.

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