Interest-free housing loans: At what cost?

Electoral Promises

Government would be compelled to increase taxes in its next mandate to fund all the promises being implemented now or to be implemented in the future.

By Prakash Neerohoo

In the run-up to the next legislative elections, likely to be held in November-December, the incumbent government is targeting the youth as a significant electoral constituency, amongst other segments of the population (old age pensioners, civil servants, women, etc.), in its segmentation marketing strategy.

First, since early 2024, it has been providing a grant of Rs 20,000 to young people on their 18th anniversary. Then last week it introduced the provision of free Internet for young people in the 18-25 age group. Now the government has announced another electoral promise for the youth: if re-elected to office, it would pay the bank interest on housing loans taken by individuals in the age group of 18-35 years to build or buy a home (house or apartment).

In this article, I would not discuss whether the latest promise is an electoral bribery although making a promise conditional upon being re-elected to office sounds like one (in spite of the Privy Council ruling that promises made to the general population are not acts of bribery but public policy statements). I would leave that debate to lawyers and political analysts. Instead, I would focus on the financial implications of interest-free housing loans for debtors and their economic implications for Government’s Treasury.

It is estimated there are about 250,000 people in the 18-35 age group, which is a significant vote bank if it can be nurtured and wooed at the right time. How many would catch the bait depends on a lot of issues such as personal income, housing affordability, civil status (married or unmarried), family size, access to land and the goal of home ownership.

Policy intent

The apparent policy intent behind the new promise is to promote access to housing for the targeted age group. Home ownership is indeed a dream for every household, specially for the working class and middle-class people who have no inter-generational wealth in real estate transmitted to them. Buying a home is a desirable opportunity for anyone who wants to get a foothold in society. It is the first step towards personal independence and eventually helps towards wealth creation for the family. While renting is always a stopgap measure in the short- or medium-term to get a roof over one’s head, in the long term a mortgaged home allows the owner to build equity in the property, which could serve as a leverage for getting bank financing for other purposes. One measure of an egalitarian society is the high rate of home ownership.

Ultimately, a mortgage-free house is a vital asset and a big part of the net worth of an individual (assets less liabilities). We know that High Net Worth Individuals (HNWIs) always include real property in their investment portfolio (real estate, cash, stocks, bonds) with the objective of reaping capital appreciation (capital gains realized upon resale) over the long term. Such is the case with all those foreign HNWIs who buy luxury residences on the coast in Mauritius thanks to the IRS/PDS projects (Integrated Resort Scheme/Property Development Scheme) promoted by the Economic Development Board (EDB).

Pertinent questions

This new promise, announced seemingly without detailed planning, raises several pertinent questions:

1. What rates of interest would Government accept to finance: 5%, 6% or 7%? Would Government impose a specific interest rate across the board for all loan applicants or would commercial banks be free to set their own mortgage rates?
2. Who would manage the funding program to process applications from prospective home buyers and finance the interest cost on housing loans? Would it be the MRA who has access to individual tax filings or another institution?
3. Would the interest-free benefit be granted to Mauritian citizens only or to all residents in the 18-35 age group, including foreigners who have citizenship or permanent residence in the country? The EDB provides citizenship/residence to foreigners who invest or work in Mauritius.
4. Would there be a ceiling on the housing loan eligible for zero interest: Rs 3, 4 or 5 million? Considering the high prices of real property in Mauritius, would the ceiling be an upper limit?
5. Would the benefit be granted only to first-time buyers who want to acquire a primary residence (i.e., personal use property)? Or would it be extended to those who acquire a secondary residence for own use (e.g., a seaside vacation property) or who acquire a property for rental purposes (i.e., income-producing property)?
6. When would the present government, if re-elected to office, implement the promise: in the first year of a new mandate or later? It is worth noting that the government’s promise to raise old age pension from Rs 9,000 to Rs 13,500 per month (for pensioners in the age group 60-64 years) was made in 2019 but was implemented in April 2024, i.e., with a time lag of five years.

Housing market

If the promise were to be implemented by a future government, the above questions would have a significant impact on the scope and coverage of the funding program. While interest-free loans might boost demand for housing, supply is faced with severe constraints in a small country of 720 square miles. The housing market is coping with some structural issues:

1. The high cost of building due to inflation, which is fuelled by the depreciation of the rupee (35% with respect to the US dollar since 2014) that increases constantly the prices of imported materials.
2. Competition from foreign investors or expatriates who acquire real property in Mauritius, thus pricing Mauritian residents out of the market. Private builders are catering to foreign demand for luxury residences, which are a source of high profits, rather than investing in social housing. They are more concerned about return on investment than social needs. The government has stepped in to build houses through the New Social Living Development Ltd (NSLD) but its original target of 12,000 houses will not be met this year (apparently only 3,500 units will have been delivered by the end of the year).
3. Land scarcity in a country with a high population density is bound to encourage the trend to build high-rise buildings of multiple apartments. However, living in an apartment may not suit the lifestyle of families with children who need more space. But buying a plot of land may be beyond their reach in a country where real estate keeps appreciating in a linear way. The prices of land are going through the roof with competing demands for commercial, industrial, agricultural and residential uses.
4. Affordability remains a big issue for many people. New homes are too expensive for prospective home buyers. A house of modest size (2,000 square feet) for an average family (four persons) cost from Rs 3 to Rs 5 million. According to a financial rule of thumb, the mortgage repayment per year should not be more than 30% of gross income (pre-tax) or 40% of net income (after-tax). In table 1, we see that a person who takes a loan of Rs 5 million without interest will need to make a repayment of Rs 20, 833 per month over 20 years, which would require a gross income of Rs 833,333 per year at 30% debt servicing. A person who takes a loan of Rs 5 million at 5% interest will need a gross income of Rs 1,319,880 to make a monthly repayment (principal plus interest) of Rs 32,997.
   

   Table 1: Calculation of mortgage interest
   Scenario		A	A(1)	B	B(1)
   Interest applicable (Yes/No)		Yes	No	Yes	No
   Loan amount	Rs	3,000,000	3,000,000	5,000,000	5,000,000
   Number of instalments in 20 yrs		240	240	240	240
   Interest rate %	%	5.00	0.00	5.00	0
   Monthly repayment (principal/interest)	Rs	19,799	12,500	32,997	20,833
   Total repayment in 20 yrs	Rs	4,751,760	3,000,000	7,919,280	5,000,000
   Cumulative interest for 20 yrs	Rs	1,751,682	0	2,919,468
   Gross annual income required	Rs	791,960	500,000	1,319,880	833,333
   Debt repayment as % of gross income	%	30%	30%	30%	30%

   Funding program

   The funding of the promise remains a big question mark at a time when the government is running a big budget deficit (Rs 63 billion for 2024-25 or 6% of GDP). Where would the money come from to finance the cost of interest on housing loans? Obviously, the money would come from the Consolidated Revenue Fund to which are credited all tax revenue (direct and indirect taxes) and non-tax revenue (grants and transfers from the Bank of Mauritius).

   Considering the current deficit, the government would need to borrow money or raise taxes to fund the interest cost. In table 2, we outline two scenarios where we assume that 5,000 applicants (uptake of 2% over 250,000 eligible applicants) would apply for an interest-free loan of Rs 3 million or Rs 5 million in Year 1 in the new mandate. With annual interest at 5% calculated on a declining balance (principal minus repayment), the total interest charge to be paid by government would be Rs 740 million in Year 1 on a Rs 3 million loan for 5,000 applicants, and Rs 1,23 billion in Year 1 on a Rs 5 million loan for 5,000 applicants. Once government takes the interest-free loan commitment, the annual interest charge would become a permanent expense on its books for 20 years. And once people in the 18-35 age group get the interest-free benefit, it would become an acquired right that would be hard to take away by any government.

   Table 2: Cost of interest to Government		Scenario A	Uptake rate	Scenario B	Uptake rate
   Eligible applicants		250,000		250,000
   Loan amount	Rs	3,000,000		5,000,000
   Interest rate	%	5.00		5.00
   Interest payable in Year 1	Rs	147,964		246,607
   Case A: Number of applicants in Year 1		5,000	2.0%	5,000	2.0%
   Total interest payable	Rs	739,820,000		1,233,035,000
   Case B: Number of applicants in Year 1		10,000	4.0%	10,000	4.0%
   Total interest payable	Rs	1,479,640,000		2,466,070,000

   Fiscal policy versus monetary policy

   Currently taxpayers are allowed to deduct interest on a housing loan from their taxable income subject to income tax. It’s a great benefit as annual interest on a loan may be a substantial amount, as we see in tables 1 and 2. Interest deductibility is allowed in some countries under fiscal policy. If government were to pay the interest cost on housing loans for 18-35 age group, there would be no interest deduction for them and income tax revenue from this group would increase, assuming they all file a tax return under the Income Tax Act. In many countries, the government uses fiscal policy to help home buyers with such measures as complete or partial exemption from Land Transfer Tax for a first-time buyer, a cash grant of 5% or 10% of the value of a loan (up to a maximum), and a tax credit of a specific amount deductible from income tax.

   By proposing to finance interest cost charged by banks, the government would be interfering with the operation of a monetary policy instrument in a market economy. Interest forms part of the cost of capital in any economy and it is used by the central bank to raise or lower the cost of credit to fight inflation or ease out of a recession. Subverting monetary policy sends the wrong signal to the economy.

   Besides, providing the interest-free benefit to one age group amounts to economic discrimination on grounds of age. A 36-year-old person who has saved money all his life to come up with a downpayment on the purchase of a home would be disgruntled to find that his younger neighbour gets a freebie from the State while he pays interest on his loan.

   The promise does not differentiate between classes of income, that is between low-income and high-income earners. It is not a progressive choice. Ideally all social benefits (old age pensions, allowances, transfers and other handouts) should be income-based and income-tested. Universality of benefits irrespective of income or wealth creates a heavy burden for the State which must increase taxes (both direct and indirect) or incur debts to fund them.

   With public debt on its way to reach 100% of GDP, the government cannot afford to continue increasing public debt without incurring a credit downgrading by international credit agencies due to lack of fiscal capacity. Therefore, the government would be compelled to increase taxes in its next mandate to fund all the promises being implemented now (e.g., free Internet for 18-25 age group) or to be implemented in the future.

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Mauritius Times ePaper Friday 13 September 2024