FI Analysis 25: Interest rate deductions and households’ loans

The tax rebate for interest expenses – the interest deduction – means that households borrow more, and can and want to pay more for homes. This means that the households experience an increase in both their liabilities and assets, which in turn could have an impact on the stability of the financial system. In this FI Analysis, we calculate the impact of a change to the interest deduction. The reason for this analysis is the direct link between interest deductions and households’ loans.

The calculations show that a reduction in the interest deduction presents a trade-off between short-term and long-term effects. In contrast to other measures to slow the increase in the loans households are taking, such as the mortgage cap and amortisation requirements, every household with a loan would be affected by the reform; not just those that take out a loan after the reform has been implemented. In the short term, those who already have a loan would experience a negative impact. Their interest expenses would increase, which has a negative impact on their cash flow at the same time as the value of their home would decrease slightly. However, given the low interest rates of today, the impact on cash flows and house prices would be relatively small. The effects increase if the interest rate increases.

The borrowing cost for all borrowers would increase if the interest deduction is reduced. For new borrowers, in other words those taking out loans after the deduction has been reduced, it would be cheaper to buy a home. They are therefore expected to borrow less and not be affected to the same extent as existing borrowers. In the long term, loans taken after the rule change would represent an increasing percentage of the total loan portfolio, and the impact on financial stability overall is expected to be positive.