While Luxembourg faces a significant and continued gap between residential housing demand and availability, recent market conditions are unlikely to prompt a substantial price correction, according to a recent report by the International Monetary Fund. Instead, the IMF recommended that Luxembourg authorities introduce a combination of measures, including tightening debt-service-to-income (DSTI) ratios and gradually reducing loan-to-value (LTV) ratios, to lower the risk of household default and credit losses. These measures, when applied in the context of supply rigidity, are anticipated to lead to a medium-term reduction in house prices and household indebtedness.

Published on Friday 7 June 2024, the report highlighted the increasing burden of debt service on firms and households due to rising interest rates. in Luxembourg has steadily risen to over 180% of gross disposable income since the mid-2010s, accompanied by a doubling of house prices over the past decade. Furthermore, the report noted that two-thirds (65%) of mortgages granted between 2018 and 2022 have a DSTI ratio higher than 40%, over half have a debt-to-income (DTI) ratio higher than 900%, and a quarter have an LTV of 90% and above.

Key metrics

The report also underscored the Luxembourg Financial Sector Supervisory Commission’s (CSSF) requirement for banks to conduct a 200-basis point interest rate stress test on new borrowers’ repayment capacity. Additionally, higher risk perception by banks following the monetary policy tightening by the European Central Bank has helped reduce the LTV and DTI.

Meanwhile, new mortgage approvals have declined due to decreased housing demand and higher rejection rates by banks. Despite this, the IMF remains concerned about the continued rise in DSTI ratios.

Government support

In response to in the real estate sector, the Luxembourg government has implemented a substantial stimulus package. Announced in January 2024, the includes measures such as declaring a state of crisis in the construction sector, extending short-term work schemes, and offering tax incentives for house purchases under “Bellegen Akt”. It was also decided to extend the public purchase programme of new residential dwellings until 2027. While these measures may temporarily boost housing demand, the IMF warned “these benefits are likely to be short-lived and would lead to a suboptimal equilibrium where affluent households will benefit disproportionately, especially in the context of long-standing housing affordability concerns, and house prices will continue to grow faster than income levels, with potential unintended effects on households’ indebtedness.”

IMF recommendations

To address these challenges, the IMF recommended recalibrating stressed DSTI ratios to around 45%-50%, possibly tying them to 2% topped interest rate stress tests required by the CSSF for new housing loans. Additionally, policymakers should consider gradually decreasing the maximum LTV, currently set at 100%, for first-time homebuyers. Implementing “a sufficiently tight combination of DSTI and LTV could lead to higher affordability of housing and lower household indebtedness in the medium term,” the IMF argued in the report.

A spokesperson for the ministry of finance told Delano on 18 June that the ministry is aware of the IMF’s reports and is studies it “with great attention”. The ministry added that the Systemic Risk Committee (CdRS) “monitors the real estate market situation closely and regularly evaluates potential adjustments to the macroprudential framework, taking into account the IMF’s observations.” The latest recommendations from the CdRS are available in French .

Updated 18 June at 5:15pm to add comment from the finance ministry .