Thursday, January 5, 2012

LTV and DTI: Taming Housing Speculation

Now that BNM’s revised guidelines on consumer lending are now in force, the question arises as to how effective they will be. The reduced loan to value (LTV) ratio of 70% for a third housing loan (implemented in 2011) appears to have had some effect on housing speculation, if house prices are any indicator – price increases have moderated across the board in 3Q 2011.

In KL for instance, house prices increased 7.9% in 3Q 2011, compared to 12.7% in 2Q 2011. The problem is 7.9% is still a fairly fast pace of appreciation – the average for the past decade (2001-2010) is just 3.5%.

So based on the new guidelines, credit decisions will take into account net income as against gross income, as well as limits on the debt to income (DTI) ratio. Will that work?

According to this new working paper from the IMF, it just might (abstract):

Do Loan-to-Value and Debt-to-Income Limits Work? Evidence from Korea
Deniz Igan & Heedon Kang

Summary: With another real estate boom-bust bringing woes to the world economy, a quest for a better policy toolkit to deal with these boom-busts has begun. Macroprudential measures could be in such a toolkit. Yet, we know very little about their impact. This paper takes a step to fill this gap by analyzing the Korean experience with these measures. We find that loan-to-value and debt-to-income limits are associated with a decline in house price appreciation and transaction activity. Furthermore, the limits alter expectations, which play a key role in bubble dynamics.

The authors’ research suggests that DTI’s have more of an impact on transactions than LTV’s, but not by much – 21% versus 16%. Conversely, LTV’s are more effective in slowing price appreciation. Transaction activity drops with a three month lag, but prices slow at a six month lag. I suspect the drop in transactions is largely due to the loan application and approval process, which means that these measures have an almost immediate effect on house buying decisions – my calculations for Malaysian loan applications and disbursements suggest an average of two months between the two points.

One concern though is that macroprudential measures such as these hurt liquidity in the housing market, something the paper mentions. In Econoenglish – you’ll find it harder to sell your house when you want to, and at fair value relative to the market. There’s also the long term implication on household savings, as for many people their houses are their main store of wealth.

But those consideration aside, it may be more meaningful over the long term to head off housing bubbles and busts before they begin. In that sense, the interference in the workings of the housing market might be a small price to pay for asset price stability.

Technical Notes:

Igan, Deniz & Heedon Kang, "Do Loan-to-Value and Debt-to-Income Limits Work? Evidence from Korea", International Monetary Fund, Working Paper No. 11/297, December 2011


  1. Selamat Tahun Baru bro..

    Besides LTV or DTI would A Scaled Up RPGT on Investors with Multi Real Estate Exposure work?

    Out here we recently introduced a scaled up Road Tax on 2nd and 3rd Car etc with link to the registered address calibrated with ownership data. Kelam kabut jugak, can't gauge the effect yet.

  2. And to you bro. How's the New Year in Indonesia?

    I'd actually favour non-term limited RPGT, but more for wealth equalisation than to dampen housing speculation. But I'd imagine an effective RPGT would have much the same effect on transactions and prices. But if the goal was to reduce household debt exposure and not just housing price appreciation, then LTV and DTI are probably better policies.

  3. There's so many ways to play with LTV with help from Developers eg: Discounts and freebies/cashback not properly captured in the transaction documents.

    Not sure how BNM monitors these.

    New Year chill out bro...too many ppl out in the city

  4. There's so many ways to play with LTV with help from Developers eg: Discounts and freebies/cashback not properly captured in the transaction documents.

    Not sure how BNM monitors these.

    New Year chill out bro...too many ppl out in the city

  5. @satD,

    Maybe time to shift to wordpress. But that would take some planning.

    @Oi Mun,

    That would be more of a wealth tax rather than something to contain price appreciation and dynamics. It's also problematical and expensive to enforce, unless you're thinking of a one time tax on disposal.

  6. Hi
    Been following your writings past few weeks. Thanks for the insightful writings. Much appreciated.

    If I may. The LTV method by itself is defeated by inflated Sale and purchase agreements, both in the sub-sale sector as well as in Developer launched sales. It is very common to see SPAs thats marked up by more than 20% or even 30% to ensure purchaser gets full loan, as well as cover legal fees, all costs, renovation costs and still have spare cash. As a property consultant/valuer, I see this regularly over the past few years and some banks are perfectly ok to provide financing on these inflated SPAs at face value. But LTV in tandem with DTI solves most of these problems.

    As for RPGT, I am all for an aggressive tax regime on profits, with owners given a rebate/ exemption for any disposals of residential properties once in 5 years, so as to not penalise the upgraders or medium/long term players. A tax rate of perhaps 50% tax on net profits, for disposals within first year, and sliding scale thereafter, could reduce speculation, and bring income to the LHDN. This obsession to buy multiple properties must be managed.

    The bigger concern I have is related to the very interesting video you had linked on income inequality. The low income group is being pushed further away from the city centres with the mid income group not affording landed properties. In JB for example, we have not seen single storey terrace houses being developed in the last year. New launches of double storey terrace houses throughout the district, being in the RM250,000 to RM350,000 range up to 2010, has over the past year shot up, with no reasonable basis, to RM400,000 onwards everywhere. The RM500,000 limit for foreigners effective January 2011 appears to have caused this. And its not like there is scarcity of land here.

    Thank you again for sharing info and your thoughts. Regards

  7. SV, thanks for dropping by.

    With respect to your remarks, what researchers have found is that, in keeping with your observations, that most measures countries have taken only have a short term impact on curbing prices and transactions. In other words, the best that can be done is to slow down speculation, not halt it entirely.

    I'm not sure that's necessarily a bad thing, as getting speculators entirely out of the market would substantially hinder liquidity i.e. you won't be able to sell at a fair market price whenever you want to. Speculative activity isn't all bad, only when it gets out of hand and prices get too divorced from reality.

    On the subject of affordable housing, I don't think there's much that authorities and regulators can do. It's only partly caused by income inequality, but the bigger share of the blame is increasing urbanisation and rural-to-urban migration; demand is far outstripping supply and prices are responding as a consequence to ration the available supply. That's part and parcel of developing into a high income economy, unfortunately, and is something we can see in the historical record of most advanced economies.

    My feeling is that the best bet would be mitigation policies, particularly improving and expanding on public transport. That reduces the pressure for affordable housing within city centres, while still allowing people to afford decent homes.

  8. Hishamh,

    Land valuation tax(LVT) definitely a wealth tax.Would have to disagree slightly that it does not have any effect on containing land price appreciation.

    When people buy residential property they only have to allocate minimal mount for land tax(some totally ignore it). If they had to take long term land tax into consideration, they would have to free up some cash from their relatively fixed income that would have been otherwise use to service bigger mortgage. Could possibly cool down borrowing for price bidding.

    LVT may also help in reducing hoarding/cornering vacant land in or next to urban areas. RPGT sometimes does not apply due to the 5 year period for investing in Reducing gambling on land price could free up some capital for more productive investment.

    One time LVT would not be as effective. It would difficult to encapsulate future land valuation changes at the initial transaction.

    The basic idea is that land price appreciation is the result of everyone's economic contribution/burden in that area. So land tax could possibly capture some fruits of this boom that can be reinvested to the people in that area itself.

    If well implemented rising LVT can help to cool property boom. In recession LVT can be adjusted downwards to reduce burden on public/businesses.

    I believe there is some districts/cities overseas that have a successful model we can learn from. There are probably enough civil servants that we can deploy in this area.

  9. SV,

    I live in JB too, I share your concerns. But things in JB are still manageable for now.

    Unlike Singapore rents track appreciation of home prices more closely, JB rentals have been relatively flat over the decade. So lower income groups still can get by renting.

    The price spike you had mentioned may not be sustainable because they are mostly restricted to new houses (which are inconvenient in terms of distance and public transport). Resale value for 2nd houses in JB is deplorable for past decade. Unless one is selling a 20 year old house or low cost house, breaking even is very hard. I expect reality to catch up soon with speculative buying.

    Unless there is some Singapore wild card, JB land availability will still exceeds its productive capacity in the short term.