LTV Limits and Borrower Risk

The paper was written by Dr. Nitzan Tzur-Ilan of the Bank of Israel Research Department.

 

The Bank of Israel has taken a series of macroprudential steps since the beginning of the current decade, intended to support the financial stability of the banks and households and to deal with the concern of the development of systemic risk in the housing market. One of the steps relates to limiting the loan to value (LTV) ratio—the mortgage amount as a percentage of the home value. The Bank of Israel imposed the limitation in October 2012, and distinguished between three groups of borrowers, establishing that Investors[1] will be able to finance, via a mortgage, 50 percent of the home value, Upgraders[2] will be able to finance 70 percent of the home value, and First-time home buyers will be able to finance 75 percent of the home value.

 

“LTV Limits and Borrower Risk” focuses on the impacts of the limitation on households’ decisions in the credit and housing markets. The research uses a specific database with information on mortgages taken out in Israel in 2012–13 and on the homes purchased with those loans. It also uses various methods to predict the LTVs that the borrowers would have chosen if not for the limitation, including the matching method. In particular, the estimation period was divided into two—before and after the imposition of the limit. In each period, a household can be found whose observed characteristics are similar to a household in the other period, which makes it possible to use the matching method to examine if there were changes in the choices of the various borrower groups in the housing credit markets.

 

The research finds that the LTV limitation achieved one of its main goals: it reduced borrowers’ leverage.

 

With regard to households’ decisions, in the housing market it was found that after the imposition of the limit, borrowers bought homes with significantly different characteristics: they were less expensive, smaller, further from the center of the country, and were located in neighborhoods with lower socioeconomic rankings. It was also found that the limitation impacted on the decisions of investors more than on other borrower types.[3]

 

In the credit market, it was found that the limitation raised the mortgage interest rate paid by the borrowers who were impacted by it and lengthened their term to repayment. The literature proposes an explanation for this phenomenon, and the research adds two other explanations.



[1] Households that own more than one housing asset.

[2] Households that need to sell their previous asset within 18 months.

[3] This finding is supported by other research as well, such as Igan and Kang (2011).​

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