The Impact of the Interest and Capital Mortgage Deduction on Belgium borrowing behavior

Annelies Hoebeeck & Carine Smolders

ERES Conference 26/06/2015

Context Belgium home ownership around 70-73%

Becoming an owner gives access to important tax benefits

VWT 1970 VWT 1981 VWT1991 SEE 2001 census 201140%

45%

50%

55%

60%

65%

70%

75%

% of dwellings occupied by owners

ContextBefore 2005: different system for interest cost, capital amortization and mortgage insurance premiums

Policy reform in 2005: Mortgage Interest, Capital amortizations and insurance Premiums assembled in one single Deduction: the MICPD

≠ Previous system: Fixed deduction, independent of loan size Double deduction for all couples Only for mortgages of 10 years or more… To obtain the owner-occupied dwelling… … which has to be the only dwelling of the household

Context € 2080 (in 2010 prices)

+ € 690 first ten years

+ € 70 for 3 or more children

MICPD extensive housing subsidy over the loan life

50% € 25 590 € 25 240 € 51 180 € 50 480 6% € 139 500

45% € 23 031 € 22 716 € 46 062 € 45 432 5% € 113 842

40% € 20 472 € 20 192 € 40 944 € 40 384 4% € 89 065

30% € 15 354 € 15 144 € 30 708 € 30 288 3% € 65 235

25% € 12 795 € 12 620 € 25 590 € 25 240 2% € 42 413

20-year loan of € 200.000 at an interest rate of

single HH with 3 or more dependent

children

single HH with less than 3 dependent

children

couple HH with 3 or more dependent

children

fiscal benefit over 20 year loan total interest cost

tax rate couple HH with less than 3 dependent

children

Context Hoebeeck & Smolders (2014) MICPD did not promote Belgian

homeownership due to its capitalization into higher house prices

Capitalization is mostly attributed to household behaviour

(e.g. Durning & Quigley, 1985)

Survey at a Belgian housing fair (October 2013): households do not

add the MICPD to their housing bid

Different transmission channel at work

Context

Different transmission channel at work:

more mortgages

higher mortgages

longer duration

MICPD

MORTGAGE MARKET

HOUSE PRICEHOUSEHOLDS

Context MICPD induced HH to take out more mortgages

Average loan length ↑ from 18 (2005) to 25 years (2010)

19981999

20002001

20022003

20042005

20062007

20082009

20102011

20122013

0

20000

40000

60000

80000

100000

120000

140000

primary market

secondary market

Real estate transactions (solid line) and mortgage financing (dashed line)

Research Question MICPD = ineffective & unfair subsidy

Higher income households get a larger subsidy

No effect on homeownership

Household pay more for their house…

… and for their loan

Sellers and financial institutions are subsidized instead of homebuyers

To which extent did the MICPD change HH borrowing behavior?

Dataset First wave of the HFCS(2010)

Questions 2327 HH

Extensive set of loan characteristics

Research unit: mortgage for the household main residence Loan origination date: 1980-2010

5 multiple imputed datafiles to treat missing values

N=534

MethodologySimultaneous Equation Model of mortgage demand (D), mortgage maturity (M) and house value (H) at loan origination date

Expectaction:

Methodology step 1 Research unit: HMR loan at origination date 2010-characteristics traced back at loan year

…trivial for most variables (age, education, kids,..)

… not for income and wealth

Assumption: 2010 HH is in the same wealth decile as in loan year

Estimate permanent income with Goodman (1995) method

Methodology step 2: cope with selection bias

Methodology step 2: cope with selection bias

First solution: restrict sample

L_year > 2000 Length ≥ 10 years

Methodology step 2: cope with selection bias

Second solution: 2-stage Heckman (1979) procedure First stage: Extend dataset with

non participation (red) estimate participation (green)

with probit model Calculate

Second stage: Add to the model

Methodology step 3: calculate fiscal benefit per HH Calculate the taxable income from the gross permanent income Determine tax bracket

Select eligible households Determine yearly deductible amount (DA) per eligible HH

~ max yearly deduction per person

~ monthly amortization (capital + interest)

Tax bracket Tax rate (t)

0-7900 25%

7900-11.240 30%

11.240-18.730 40%

18.730-34.330 45%

> 34.330 50%

Max yearly deduction

Basic amount 2080 €

First 10 years + 690 €

First 10 years, ≥ 3 children + 70 €

Methodology step 4: cope with simultaneity and endogeneity Cross-equation correlation: SUR

Endogeneity of D,M, H, MICPD variable and R: 2SLS Instruments for D,M,H: all exogenous variables of the model Instruments for R:

interest rate on long term/short government bonds Instrument for MICPD over loan life: maximum yearly deduction SUR + 2SLS= 3SLS

Methodology step 5: combine results

+) ] ² (Rubin, 1987)

(Harel, 2009)

Results Permanent incomeHarel R²= 0.43

coef seconstant 11.061*** 0.107

age centered 0.001 0.003age centered squared -0.001*** 0.000number of children -0.005 0.021nubmer of other properties 0.113*** 0.042bonds 0.121° 0.086shares 0.097* 0.058other financial assets 0.011 0.126savingsaccounts 0.080 0.074mutualfunds 0.155*** 0.058high income reference period 0.036 0.100low income reference period -0.154** 0.065

Permanent income

Job, education and marital status (reference category: two working, married persons with tertiary education)Two persons working, …… cohabiting, with tertiary education -0.280 0.366… cohabiting, one tertiary education, one lower -0.128 0.085… widowed, one tertiary education one lower -1.665*** 0.595… cohabiting, with secondary education -0.137 0.103… cohabiting with primary education 4-1.96** 0.812One person working, one not working, …… cohabiting, with tertiary education -0.005 0.215… married, with tertiary education -0.219** 0.110… married, with secondary education -0.586*** 0.108… cohabiting, with secondary education -0.403** 0.182… cohabiting or married, with primary education -0.685*** 0.250Two persons retired, …… married, with tertiary education -0.884** 0.390… married, one tertiary and one lower education 0.257 0.540… married, one secondary and one lower education-0.861° 0.540One retired and one non working person, …… married or cohabiting, with tertiary education -0.930 0.600… married, with secondary education -0.804* 0.482… cohabiting, with primary education -1.073 0.799Two non-working, married persons -0.858* 0.525Two unemployed persons -0.844° 0.538Single household, …… with a regular job, tertiary education -0.569° 0.368

… with a regular job, secondary education -0.743° 0.474… with a regular job, primary -0.840 0.668… on sick, maternity leave -0.981 0.839… unemployed -1.123° 0.741

… non working -1.150° 0.795

Results Selection regression

% correct predicted= 0.834%

Intercept model: 0.587²+(1-0.587)^2= 0.515

constant -177.9*** 14.96Year of property acquisition 0.0893*** 0.007Household age 0.0468° 0.030Household age² -0.0007*** 0.0003Second residence -0.189* 0.179Retired householders -0.957*** 0.291

n=1056

Participation

ResultsMc Elroy R²= 0.648

N=534

coef se

Constant 6.415*** 2.228

T 0.038** 0.018

ln (H) 0.392** 0.175

R -0.139*** 0.048

Refinanced loan -0.052 0.081

Second HMR loan -0.331*** 0.076

Loan purpose= renovation -0.724*** 0.099

Loan purpose= renovation and purchase HMR-0.150* 0.080

Permanent income (in 10 000) -0.003 0.002

Wealth decile 0.013 0.012

Mean HH age -3.02E-04 0.006

Self-employed 0.241*** 0.085

Tertiary Eduaction 0.166** 0.065

Received inheritance or gift -0.069 0.063

Inheritance expected -0.037 0.051

Loan year prior to 2005 0.205** 0.101

MICPD over loan life 0.067* 0.036

Harel R² adjusted 0.414

Ln (mortgage demand) (D)

Results coef se

constant -11.522* 6.540

ln(D) 3.323*** 0.548

R 0.738** 0.358

Refinanced loan -0.976** 0.498

HH has other loans 2.510*** 0.702

Permanent income (in 10 000) -0.048*** 0.011

Wealth decile -0.095 0.079

Mean HH age -0.285*** 0.025

Self-employed -1.094* 0.564

Tertiary eduaction -1.230*** 0.452

Number of kids 0.461*** 0.173

Size of the house (reference category: >200m² )

[50m²-80m²] 4.457*** 1.074

[80m²-100m²] 1.979** 0.791

[100m²-120m²] 1.265** 0.612

[120m²-150m²] 0.717 0.537

[150m²-200m²] -0.051 0.473

loan year prior to 2005 2.580*** 0.728

MICPD over loan life 1.097*** 0.198

λ 1.360** 0.601

Harel R² adjusted 0.466

Mortgage maturity (M)

Results coef se

constant 9.585*** 0.710

Ln(D) 0.1617* 0.060

Second HMR loan 0.184* 0.061

Permanent income 0.005*** 0.001

Wealth Decile 0.0092 0.008

Mean HH age 0.0154*** 0.002

Self-employed 0.1225** 0.055

Recieved inheritance or gift 0.0784** 0.035

Inheritance expected 0.114*** 0.042

Size of the house (reference category: >200m² )

[50m²-80m²] -0.541*** 0.101

[80m²-100m²] -0.4672*** 0.076

[100m²-120m²] -0.322*** 0.060

[120m²-150m²] -0.307*** 0.051

[150m²-200m²] -0.192** 0.047

Average dwellingprice (in 10 000) 0.012 0.011

Total transactions (in 10 000) -0.018 0.019

Loan year prior to 2005 -0.197* 0.108

MICPD over loan life 0.008 0.019

Harel R² adjusted 0.507

ln (house value) H

Conclusion MICPD ↑mortgage maturity and demand

MICPD has no direct effect on the house price

Capitalization happens through the mortgage market

Financial institutions= real beneficiaries of the MICPD

MICPD should be eliminated