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Mortgage Borrowing Caps: Leverage, Default, and Welfare

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  • Leonor Queiró
  • João G. Oliveira
Abstract
We explore the transmission channels of macroprudential policy in the form of caps on household mortgage borrowing. We employ an overlapping generations model with uninsurable labor income risk, housing, and long-term defaultable loans to measure the long-run economic impact of loan-to-value (LTV) and debt payment-to-income (PTI) caps on mortgage contracts in an economy without aggregate risk. We calibrate the model to Portugal, which implemented a 90 percent LTV cap and a 50 percent PTI cap. We find that the leverage cap can lower mortgage debt to output by one-third and eliminate the default rate. However, this comes at the cost of a 2 percent reduction in household welfare, chiefly among income and wealthpoor agents. PTI limits reduce default by limiting debt service but increase indebtedness and household leverage. This mechanism stems from the interaction between labor market risk and the payment-to-income cap: Households fear future adverse income shocks may constrain their access to credit markets and borrow earlier with lower down payments. Finally, we find that the policymaker can achieve similar cuts in default relative to the policy with a smaller welfare cost by setting a less stringent LTV cap or a more restrictive PTI cap.

Suggested Citation

  • Leonor Queiró & João G. Oliveira, 2023. "Mortgage Borrowing Caps: Leverage, Default, and Welfare," Working Papers w202304, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w202304
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    References listed on IDEAS

    as
    1. Jack Favilukis & Sydney C. Ludvigson & Stijn Van Nieuwerburgh, 2017. "The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk Sharing in General Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 125(1), pages 140-223.
    2. Emmanuel Farhi & Jean Tirole, 2012. "Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts," American Economic Review, American Economic Association, vol. 102(1), pages 60-93, February.
    3. Daniel Greenwald & Adam Guren, 2019. "Do Credit Conditions Move House Prices?," 2019 Meeting Papers 1334, Society for Economic Dynamics.
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    Cited by:

    1. Paz-Pardo, Gonzalo & Castellanos, Juan & Hannon, Andrew, 2024. "The aggregate and distributional implications of credit shocks on housing and rental markets," Working Paper Series 2977, European Central Bank.

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