The Sensitivity of Homeowner Leverage to the Deductibility of Home Mortgage Interest

Mortgage interest tax deductibility is needed to treat debt and equity financing of homes equally. Countries that limit deductibility create a debt tax penalty that presumably leads households to shift from debt toward equity financing. The greater the shift, the less is the tax revenue raised by the limitation and smaller is its negative impact on housing demand. Measuring the financing response to a legislative change is complicated by the fact that lenders restrict mortgage debt to the value of the house (or slightly less) being financed. Taking this restriction into account reduces the estimated financing response by 20 percent (a 32 percent decline in debt vs a 40 percent decline). The estimation is based on 86,000 newly originated UK loans from the late 1990s.