Mortgage Borrowing Caps: Leverage, Default, and Welfare

Leonor Queiró and João Gouveia-Oliveira

Working Papers from Banco de Portugal, Economics and Research Department

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.

JEL-codes: D60 E21 E44 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-des, nep-dge and nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:ptu:wpaper:w202304

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