AMSTERDAM—The slump in the Dutch housing market deepened in July as prices posted the steepest drop on record, highlighting the challenges facing the Netherlands ahead of next month’s general elections.

With prices now plumbing levels last seen in 2004, the downturn is weighing heavily on household consumption and has raised concern about the country’s huge mortgage debt pile, among the largest in Europe

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House prices fell 8% from a year earlier, statistics bureau CBS said Tuesday, the largest decline in the 17-year history of the agency’s house-price index. Prices fell 4.4% in June and 5.5% in May.

“This is more than we had expected. The rate of decline has been volatile, but this is bad news,” said Rabobank economist Maarten van der Molen.

House prices have fallen about 15% since their peak in August 2008 amid a stagnant economy, more stringent bank-lending criteria and weak consumer sentiment.

The fall in house prices in the Netherlands isn’t as severe as the housing crashes that have hit Ireland and Spain, but it remains one of the biggest threats to one of Europe’s so-called core economies. The Dutch economy grew 0.2% in the second quarter from the previous quarter, joining Germany and France in escaping the slump hitting their southern neighbors.

The Netherlands Bureau for Economic Policy Analysis, or CPB, expects gross domestic product to contract by 0.8% this year and return to a modest 0.8% growth rate in 2013. The CPB is an independent fiscal watchdog for the government and its economic adviser.

Regulators blame loose lending practices in the late 1990s and early 2000s and a tax relief program for home buyers that distorted the Dutch housing market. As a result, they say, the country’s banks have become too reliant on wholesale funding to finance their large mortgage books. At around €640 billion ($790 billion), Dutch mortgage debt is roughly the size of the country’s entire economic output last year.

The Dutch central bank warned earlier this year that a prolonged slump poses a risk to the financial system as banks could face rising loan losses and more trouble securing funding. It could also squeeze public finances, as the Dutch government guarantees around €140 billion in home loans.