Mortgage Credit Inequality: Impact on Rents and Housing

Mortgage credit inequality is driving increasing rents and high house prices, putting significant strain on household budgets. This persistent rise in housing costs is forcing families, particularly younger people and urban dwellers, to allocate a larger portion of their income towards securing a home. In some cases, they are either downsizing or extending their commutes to reduce their housing expenses. These shifts are occurring in a broader context of stricter housing market regulations introduced in the aftermath of the global financial crisis. Notably, many governments adopted policies that limited access to mortgage credit by setting tighter borrowing conditions. While these measures aimed to improve financial stability, their unintended consequences are significant. Specifically, they may drive up rents and worsen inequality in the housing market.

Mortgage Credit and Housing Market Dynamics: Mortgage Credit Inequality

The interrelationship between the mortgage, housing, and rental markets is crucial to understanding the dynamics of housing affordability. Typically, individuals rent their first homes before purchasing property as they accumulate savings for a downpayment. Over time, these individuals repay their mortgages, gradually building wealth. The wealthiest in society may then become property investors, purchasing buy-to-let homes and providing rental accommodation for others.

When credit is limited, it becomes much harder for people to obtain mortgages. This results in a bifurcation of outcomes. Wealthier households, constrained by borrowing limits, might adjust by buying smaller or less expensive properties, thus reducing the loan amounts they require. However, individuals who are already seeking more affordable homes could find themselves completely priced out of the market. As a result, they may remain renters for longer periods or may never be able to purchase property at all.

The Growing Demand for Rental Accommodation

With fewer people able to buy homes, the demand for rental properties inevitably increases. At the same time, the demand for properties available for purchase declines. This creates a situation where additional rental housing is required to meet the growing demand. For this to occur, more investors must enter the market and purchase homes to let. To attract these new landlords, rents will have to rise.

Importantly, those who are more constrained financially and less liquid than incumbent landlords are less likely to invest unless they are offered higher returns. Consequently, the influx of buy-to-let investors into the market necessitates higher rent levels. This increase in rents places a significant strain on lower-income households, particularly those who are already struggling with the high cost of living.

Housing Ownership Concentration Among the Wealthy

As a result of these changes, the balance of the housing market shifts. Homeownership increasingly concentrates among wealthier segments of society, leaving lower-income and younger households with fewer opportunities. As a result, these groups face greater challenges in securing property. Although house prices may decrease slightly in response to reduced demand, the impact on the overall wealth distribution is far more pronounced. While fewer households are able to purchase property, the concentration of housing ownership among the wealthy increases.

The Effects of Mortgage Credit Limits on Housing Prices and Rents

The impact of tightening mortgage credit conditions can be quantified through economic models. A study by Castellanos, Hannon, and Paz-Pardo (2024) explored the effects of borrower-based macroprudential interventions on housing markets. These interventions, similar to the measures implemented in Ireland in 2015, imposed limits on how much individuals could borrow to purchase a home. Specifically, they introduced a 20% downpayment requirement and a loan-to-income ratio cap of 3.5.

To illustrate the impact of these restrictions in the UK, consider a household with significant savings. Under such borrowing constraints, this household would be limited in the amount they could borrow, even though their financial situation would allow for a higher loan. Similarly, households with a strong annual income would face borrowing limits, regardless of their overall financial standing, limiting their ability to access larger loans.

Using a life-cycle model of homeownership, the authors found that the imposition of borrowing limits resulted in a rise in rental prices. Four years after the introduction of these limits, rents had increased by 4%, and the new equilibrium level of rents was 3% higher than before the intervention. In contrast, house prices remained relatively unchanged, decreasing by only a marginal 0.01%. The ownership rate decreased substantially, with homeownership dropping by approximately two percentage points. This led to a more concentrated distribution of homeownership, with wealthier individuals owning a larger proportion of the housing stock.

Empirical Evidence from Ireland: Mortgage Credit Inequality

The empirical evidence gathered from areas in Ireland where the borrowing limits were most restrictive supports these theoretical findings. The regions that experienced the greatest reductions in house prices also saw the most significant increases in rents. These findings suggest that limiting access to mortgage credit reduces the ability of many households to purchase homes. As a result, demand for rental properties rises, which drives up rents.

For households that are not currently homeowners and rely on mortgage credit to access homeownership, these restrictions result in a significant decrease in welfare. The effects are particularly harsh for younger households and those in the lower-to-middle income brackets. The study showed that reduced access to mortgage credit lowers the welfare of would-be buyers, particularly younger ones. Furthermore, the rise in rents has an even more detrimental effect on lower-income households.

Interestingly, the owners of rental properties, on the other hand, benefit from the increased rents. These property owners are largely unaffected by the changes in mortgage lending conditions and, in fact, see higher returns from their investments.

The Role of Higher Interest Rates in Housing Affordability

In addition to studying the effects of mortgage credit restrictions, the authors also investigated how an increase in real interest rates affects housing markets. An increase in the real interest rate can have a similar impact on the housing market as tighter credit conditions. In the short term, higher interest rates tend to lead to rising rents, declining house prices, and lower homeownership rates.

However, there are some key differences between the effects of higher interest rates and stricter borrowing limits. Higher interest rates make saving for a downpayment more attractive, as financial assets become relatively more profitable compared to property investments. This, in turn, increases the incentive for small investors to stay in the rental market, driving up rents further. While the increase in interest rates makes saving for a downpayment easier, this effect is limited, and tenants remain worse off overall.

Another important consequence of rising interest rates is that current mortgage holders with variable-rate loans will see their repayment costs rise. This can further decrease their welfare, especially for lower-income households.

The Interplay Between Interest Rates and Macroprudential Policies: Mortgage Credit Inequality

When analysing the combined effects of interest rate hikes and macroprudential credit limits, the authors found notable differences. Specifically, house prices and rents responded less significantly to higher interest rates in regions with existing credit limits. “This suggests that macroprudential policies can help mitigate the transmission of shocks from the financial sector to housing. Moreover, these policies dampen the negative impact of interest rate increases on both rents and house prices.

Conclusion: A Complex Housing Affordability Crisis

The findings highlight how mortgage credit inequality contributes to the complex and multifaceted nature of the housing affordability crisis. Both macroprudential credit restrictions and increases in interest rates disproportionately affect lower-income and younger households. Consequently, these measures close the door to homeownership and drive up rents. While these policies may contribute to financial stability, they also have significant negative consequences for those already struggling with high housing costs.

Policymakers, particularly those involved in financial regulation, should carefully consider these unintended consequences when designing and implementing macroprudential measures. The European Central Bank (ECB) and national central banks within the European System of Central Banks (ESCB) strongly support these measures. They argue that such actions contribute significantly to financial stability across the region. However, the findings suggest that policymakers must consider the distributional impacts of these measures in the housing market. Specifically, they should address the increased inequality these measures may create for households.

In the longer term, higher profits in the housing and rental markets are expected to encourage more construction. Consequently, this could increase rental activity and alleviate some short-term effects of credit constraints. However, in many cities, regulatory barriers to housing supply could delay this process and exacerbate existing issues. Consequently, the negative impacts of credit restrictions may persist, particularly for younger and lower-income households.

As such, addressing the housing affordability crisis requires a careful balance between ensuring financial stability and promoting greater access to homeownership. Only by considering the broader socio-economic effects of housing policies can we hope to mitigate the growing inequality in the housing market.