Lower capital market rates increase borrowing capacity
The increase in house prices is primarily attributable to homebuyers’ access to ever cheaper finance. International developments have put capital market rates on a downward trend in recent decades. As a result, mortgage interest rates in the Netherlands have also fallen sharply from an average of 7% in 1995 to around 2% now. As mortgage interest declines, households can take up higher loans at the same monthly cost, and thus bid more for the same house. Moreover, real estate investors can afford to pay higher prices when interest rates are low and related required returns are lower. After all, the discounted value of future rental income increases as required returns fall. This causes the investment value of a home to go up due to discounting effects.
House prices are closely related to borrowing capacity
Figure 1 shows that house prices have moved closely in line with the trend in income standards for mortgage loans and the resulting maximum loan amounts in the past 25 years. The maximum loan amount has increased in recent years as income went up and mortgage rates fell. It was also affected by changes in the income standards set by the National Institute for Family Finance Information (Nibud). The close relation between house prices and maximum loan amounts is hardly surprising. In the Netherlands, the vast majority of homes are financed by mortgage loans, and relatively many households – both first-time buyers and homemovers – take out loans close to their maximum borrowing capacity. This is due to the favourable tax treatment of mortgage debt and home ownership wealth, in addition to the discounting effects referred to above that can drive up a home's investment value to levels that exceed the borrowing capacity of most households. House prices have therefore been strongly driven by the borrowing capacity of households over the past decades. In the shorter term, however, house price trends may differ from that borrowing capacity, for example due to concerns among households and investors about their future financial situation.