Brendan Burgess
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For non-economists, the title is a bit offputting but I hope people read it, and the first few replies.
Composition Effects and Loan-to-Value Limits
Composition Effects and Loan-to-Value Limits
The budgeting scenario has been described as follows:
“Consider a couple who wish to purchase a €300,000 property. With a LTV limit of 80% this will require that they save €60,000 for the down payment whereas if they were allowed to borrow 85% they would only need savings of €45,000.”
This oft-repeated budgeting scenario misrepresents the nature of market-wide LTV limits imposed by the Central Bank.
This budgeting scenario gives the impression that the policy decision is about imposing/not imposing the LTV constraint on only one particular buyer rather than market-wide. It misses the large compositional effects since leveraged property buyers compete with one another for properties. The degree of leverage allowed in the banking system feeds into property prices, and this affects the opportunity set of purchasers.
A dual statement of the constrained household budgeting problem gives a better framework for thinking about the issue:
“Consider a couple who have saved a down payment of €45,000. If they face an LTV limit of 80% they can only pay €225,000 for a property, whereas if they are allowed to borrow 85% they can pay €300,000.”