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Household Leverage and the Deductibility of Home Mortgage Interest: Evidence from UK House Purchasers

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  • Patric H. Hendershott
  • Dr. Gwilyn Pryce
  • Dr. Michael White

Abstract

During the last quarter century, mortgage interest deductibility has been gradually phased out. In 1974 a ceiling was set on the size of the mortgage eligible for interest deductibility (œ30,000 since 1983) and, beginning in 1993, the maximum rate at which interest under that ceiling could be deducted was reduced in four steps to zero in 1999. The combination of these changes gives a rich array of different debt tax penalties for different households in different years. We analyze over 117,000 loans originated in the UK during the 1988-91 and 1995-98 periods to finance home purchases. We first estimate a logit to predict whether a household's loan exceeds the œ30,000 ceiling. These predicted probabilities are then employed to construct debt tax penalty variables that are used to explain household LTVs on loans to finance home purchases. The penalty variables depend on the predicted probability of having a loan that exceeds the ceiling, the market mortgage rate, and exogenous household specific tax rates. From these results we compute estimates of the impact of removing deductibility on initial LTVs in the UK and on the weighted average cost of capital for owner-occupied housing. Removal of deductibility is estimated to reduce initial LTVs, which mitigates the rise in the weighted average cost of capital, by about 30 percent, with the reduction varying with household age, loan size (above or below the œ30,000 limit) and tax bracket.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9207.

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Date of creation: Sep 2002
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Handle: RePEc:nbr:nberwo:9207

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  1. Patric H. Hendershott & Joel Slemrod, 1982. "Taxes and the User Cost of Capital for Owner-Occupied Housing," NBER Working Papers 0929, National Bureau of Economic Research, Inc.
  2. Woodward, Susan E. & Weicher, John, 1989. "Goring the Wrong Ox: A Defense of the Mortgage Interest Deduction," National Tax Journal, National Tax Association, vol. 42(3), pages 301-13, September.
  3. Follain, James R. & Ling, David C., 1991. "The Federal Tax Subsidy to Housing and the Reduced Value of the Mortgage Interest Deduction," National Tax Journal, National Tax Association, vol. 44(2), pages 147-68, June.
  4. Goodman, Allen C. & Kawai, Masahiro, 1982. "Permanent income, hedonic prices, and demand for housing: New evidence," Journal of Urban Economics, Elsevier, vol. 12(2), pages 214-237, September.
  5. Ermisch, J. F. & Findlay, J. & Gibb, K., 1996. "The Price Elasticity of Housing Demand in Britain: Issues of Sample Selection," Journal of Housing Economics, Elsevier, vol. 5(1), pages 64-86, March.
  6. Robert M. Dunsky & James R. Follain, 2000. "Tax-Induced Portfolio Reshuffling: The Case of the Mortgage Interest Deduction," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 28(4), pages 683-718.
  7. Richard K. Green & Patric H. Hendershott & Dennis R. Capozza, 1996. "Taxes, Mortgage Borrowing and House Prices," Wisconsin-Madison CULER working papers 96-06, University of Wisconsin Center for Urban Land Economic Research.
  8. Devereux, Michael P. & Lanot, Gauthier, 2003. "Measuring tax incidence: an application to mortgage provision in the UK," Journal of Public Economics, Elsevier, vol. 87(7-8), pages 1747-1778, August.
  9. Patric H. Hendershott & Thomas G. Thibodeau, 1990. "The Relationship between Median and Constant Quality House Prices: Implications for Setting FHA Loan Limits," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 18(3), pages 323-334.
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Cited by:
  1. Jappelli, Tullio & Pistaferri, Luigi, 2004. "Incentives to Borrow and the Demand for Mortgage Debt: An Analysis of Tax Reforms," CEPR Discussion Papers 3903, C.E.P.R. Discussion Papers.
  2. Catarina Figueira & John Glen & Joseph Nellis, 2005. "A Dynamic Analysis of Mortgage Arrears in the UK Housing Market," Urban/Regional 0509006, EconWPA.
  3. Dan Andrews, 2010. "Real House Prices in OECD Countries: The Role of Demand Shocks and Structural and Policy Factors," OECD Economics Department Working Papers 831, OECD Publishing.
  4. Luci Ellis, 2006. "Housing and Housing Finance: The View from Australia and Beyond," RBA Research Discussion Papers rdp2006-12, Reserve Bank of Australia.

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