Home Purchasing Subsidies, Adverse Selection and Mortgage Performance

We find that home affordability policy induces the marginal buyers to take home loans and they are more likely to be delinquent in subsequent payments. India government increased total income tax exemption limit by 50,000 INR (US $ 833) in July 2014. The sectional exemption limits for both the principle and interest payment of home loans were also increased by US$833. We find that there are more loans (250%) with low credit limit originated in two months following the policy announcement. The loans originated in the two months are shorter in loan term, smaller in required monthly installment and borrowed by younger people but with similar interest rate. The delinquency rate in September in the next fiscal year is 1.14%, 1.22% and 1.27% higher for the loans originated in July, August and September respectively compared than those originated in May and June. Controlling for all the other loan level and consumer level observable characteristics, the significantly higher delinquent rate remains. Such effect is more pronounced for the regions with higher growth rate of GDP per capita and GDP of construction. We thus argue that home affordability policy has a distortion effect over some marginal buyers who are induced to rush into the housing market and they may over-estimate their repayment capability.