A comparison of United States and United Kingdom research

The UK mortgage market context is important when comparing US and UK research. For example, the UK has a system of variable rate mortgages with fixed rate debt typically being fixed for short periods of 1 to 5 years. Thus reactions to changes in the current mortgage interest rate could differ in elasticity, as most contracts reverted eventually to the variable rate. Also, unlike US research (Brueckner & Follain 1989), there is no evidence of simultaneity in the choice of mortgage instrument and housing/mortgage demand for the UK (see Leece 2000b, 2001b). Given these differences then we might predict significantly different elasticities of mortgage/housing demand with respect to the net of tax mortgage interest rate. Of course, this is what we find with US estimates of 1.00 or 1.5 and UK elasticities of 0.24 and 0.20. Differences might also reflect the perceived gap between mortgage rates and the relevant rate of return on the alternative investment to housing.

Tax benefits on UK mortgage interest rates were automatically calculated at source under a scheme called MIRAS (mortgage interest relief at source), while in the US, households are responsible for claiming relief through self-assessment. Some UK borrowers could separately claim tax relief at the higher rate of tax up to 1991 when mortgage interest relief was reduced to the standard rate. Whether tax deductions have, or have not, been claimed has proven to be a significant impact upon mortgage demand in US research (Ling & McGill 1998; Dunsky & Follain 2000). With automatic deduction this is clearly less the case for the UK; as noted, the tax relief on mortgage interest payments in the UK was finally abolished in April 2000.

Ling & McGill (1998) suggest that in the US the general belief is that the after tax cost of equity exceeds the net of tax mortgage interest rate. This is also the position adopted by Brueckner (1994a). A criticism here might be that with imperfect capital markets, and less than complete portfolio diversification, the opportunity cost of equity in property might vary between households. The borrower's actual perception of the relevant opportunity cost of equity in a residence is an area that merits further research. Estimating the cost of equity for owner occupied property is a topic where a number of different techniques have been applied, and a variety of estimates made (see Gillingham 1983; Miles 1992; and Leece 2000b). The advantage of the UK study reported above is that we can be fairly certain that the mortgage rate is perceived to be lower than the forgone return on investment.

A direct comparison of parameter estimates obtained in US and UK research are difficult, and may not be very meaningful. However, there are a number of general lessons to be drawn from such a comparison. The importance of locating the appropriate opportunity cost of equity in property has been noted. The elasticity of demand for mortgage debt with respect to the mortgage interest rate may vary according to the discrepancy between net of tax mortgage rates and the appropriate forgone rate of return. Key characteristics of the system of housing finance, including prevalent mortgage designs might also influence these relationships. For example, the short periods for which mortgage rates are fixed on fixed rate debt in the UK may have resulted in a more short-term perspective on movements in interest rates, and a focus upon comparative costs of mortgage instruments (Leece 2001a). Later chapters will provide further comparisons between US and UK decisions on mortgage size, in particular the simultaneity of mortgage demand and choice of mortgage contract design.

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