The Effects of Loan-to-value Ratio Ceilings on House Prices

paper; slide: MEA annual meeting; slide: NOE Workshop

Loan-to-value ratio (LTV) ceiling is a government policy that puts a cap on households’ mortgages relative to their house value, often intended to reduce booms in house prices. This paper studies the effects of this policy on house prices, using a simple two-period overlapping-generations model featuring within-generation inequality. In contrast to popular belief, we find that a strict (low) loan-to-value ratio ceiling raises long-run house prices, as lenders respond to the policy by substituting from mortgage lending to purchasing more houses. The policy’s positive effect on house prices is more severe with greater inequality. A strict ceiling is especially harmful to the poor. Taxes can only intensify the positive effect on house prices, although they can mitigate the adverse effects on welfare.

Article tags: Working