High levels of debt relative to disposable income or wealth can indicate financial vulnerability for households. Photo: Shutterstock

High levels of debt relative to disposable income or wealth can indicate financial vulnerability for households. Photo: Shutterstock

Households in Luxembourg are more likely to default on loans than just two years ago and the debt-to-disposable-income ratio is rising, an analysis by Luxembourg’s central bank shows, but with only a small share of poor families holding mortgages, risk is relatively contained.

Economists from Luxembourg’s central bank (BCL) on 16 June published as  examining household indebtedness and vulnerability to rising interest rates in the current context of high inflation.

While several indicators suggest an increase in financially vulnerable households in the grand duchy between 2018 and 2021, the study shows that the lowest quintile (20%) of households holds a smaller share of debt, including mortgages.

This limits the potential impact on private consumption and aggregate economic activity. The report is based on data from the Luxembourg Household Finance and Consumption Survey (HFCS).

This limited exposure helps mitigate the potential decrease in household consumption and its impact on overall economic activity.

According to BCL, the ratio of ‘household debt-to-disposable income’, an indicator for vulnerability under prolonged financial stress conditions, has increased significantly over the years. It rose from 75% in 1995 to 180% in 2021.

Additionally, simulations suggest that in 2022 and 2023, debt service grew at a faster rate than income, leading to an increase in the probability of loan default on average.

But it wasn’t all bad news. The debt-to-assets ratio and the loan-to-value ratio remained relatively steady between 2018 and 2021, as household debt and real estate values increased at similar rates.

Moreover, the ratio of net liquid assets to income showed a slight improvement during the same period.

When examining credit risk, which is concentrated among low-income households, the situation is not entirely dire. Although the most disadvantaged households are the most vulnerable, systemic and macroeconomic risks appear to be relatively contained.

This is evident in the fact that the lowest income quintile, despite being indebted, represents only 11% of the number of mortgage contracts and a mere 9% of aggregate household sector debt.

According to the BCL, the study illustrates that the “automatic stabilisers embedded in Luxembourg’s institutional setting, as well as the timely fiscal policy interventions, succeeded in limiting the deterioration of households’ financial situation.”