Bank of England researchers find tighter credit cuts house prices but lifts rents
A Bank of England staff working paper using Irish data finds tighter mortgage credit lowers house prices on impact but raises rents in the short and long run.
Tighter mortgage lending limits cut house prices on impact but push rents higher for years, Bank of England researchers said on Friday in a staff working paper that uses Ireland as its case study.
Staff Working Paper No. 1,213 is by Juan Castellanos of the Bank of England, Andrew Hannon of the National Bank of Belgium and Gonzalo Paz-Pardo of the European Central Bank.
The authors build a model of housing and rental markets in which prices and rents are set by the interaction of renters, homeowners and landlords with different ages, incomes and wealth.
They test two changes in credit conditions: rules introduced in Ireland in 2015 limiting loan-to-value and loan-to-income ratios on new mortgages, and shocks to real interest rates.
The Irish rules included a minimum 20% downpayment on a house and a maximum 3.5 ratio of mortgage debt, which the authors treat as an example of a credit shock.
Their central result is stated plainly: “We find that contractionary credit shocks reduce house prices on impact but increase rents over both the short and long run.”
On house prices, the model estimates that the Irish reform lowers them by 0.9% on impact.
Rents respond more slowly but by more, rising 4.5% at their peak, seven years after the reform, and settling 2.6% higher in the long run.
The reform also reduces the homeownership rate by 3 percentage points in the long run, while landlords come to hold a larger share of the housing stock.
The mechanism is that a credit tightening can keep prospective buyers in the rental market for longer, so more landlords must enter to supply homes and rents rise to clear the market.
The authors say their model “reveals that constraining housing credit has a stronger impact on renters”, who lose out through both rental prices and the housing purchase decision.
Small landlords matter to the result: in Ireland more than 50% of all tenancies are held by households that own only one or two rental properties.
That structure, rather than large institutional owners, is why rents in the model respond to credit conditions, because individual landlords need extra compensation to buy more homes to let.
In a second exercise the authors examine real interest rate shocks, which they find also raise rents, consistent with the result for lending limits.
The research is not Bank policy. Staff Working Papers, the Bank explains, “describe research in progress” and are published “to elicit comments and to further debate”.
The views expressed are solely those of the authors and cannot be taken to represent the Bank or any of its committees.
The authors also say the work does not “provide a fully integrated assessment of the costs and benefits” of such policies, because it does not model the cyclical build-up of financial-sector risks.
