What influences the growth of household debt?

Author:Jacobsen, Dag Henning

Household debt has increased by 10-11 per cent annually since 2000. In the following, the factors underlying the strong growth in debt are analysed using an empirical model. The debt growth of recent years is found to be related to developments in the housing market and to the decline in interest rates since December 2002. As a result of the sharp rise in house prices from 1998 to 2001, debt growth remained at a high level while house prices declined in the latter half of 2002 and into 2003. This reflects that only a small portion of the housing stock changes hands each year. Even if house prices level off following a rise, there will be a long period during which houses change hands at a higher price than the last time they were sold. An increase in house prices will therefore contribute to debt growth for a long time. Households may increase their debt further by raising loans to finance consumption and investment with collateral in the increased value of their dwellings. This type of borrowing has probably increased in recent years.


Norges Bank shall promote price stability and financial stability. Monetary policy is oriented towards achieving low and stable inflation, defined as an annual rise in consumer prices of close to 2 1/2 per cent over time. At the same time, monetary policy can affect financial stability, since the interest rate influences private sector debt and prices for houses and securities. Strong growth in debt and in asset prices may result in financial imbalances (Borio and Lowe, 2002). Such imbalances may weaken the stability of the financial sector and result in unstable inflation and employment.

Household debt has increased by 10-11 per cent annually for the past five years. The strong growth in debt is often attributed to rising house prices and high turnover in the housing market. However, debt growth remained above or close to 10 per cent even when house prices declined in the latter half of 2002 and into 2003 (see Chart 1). This indicates that house prices influence debt with a considerable time lag. The fall in interest rates since December 2002 may explain why debt growth accelerated in the second half of 2003 and first quarter of 2004.


The purpose of this article is to shed light on factors that influence the growth of household debt. In particular, we evaluate how debt growth hinges on developments in the housing market. We estimate a model of household debt on quarterly data from 1994 Q1 to 2004 Q1. The model contains effects of house prices, the housing stock, the number of house sales, banks' lending rates, the unemployment rate, total wage income in the economy and the number of students aged 20-24 as a share of the total population. An earlier version of the model was presented in Inflation Report 2/03.

Factors that influence household debt

Household debt is determined by demand for loans and banks' lending policy. In this section we discuss (a) the relationship between households' debt and their behaviour in the housing market, (b) demand for loans to finance consumption and investment and (c) banks' behaviour.

The relationship between households' debt and their behaviour in the housing market

Household debt is largely related to the purchase of dwellings. A household buying a dwelling for the first time will normally debt-finance the purchase to a large extent. Established households will also normally increase their borrowing if they purchase a more expensive dwelling than the one they already own. Developments in the housing market are therefore important for debt growth. Since different types of house sales have different effects on gross debt, it is useful to classify these sales. We distinguish between purchases of new homes, first-time purchases and last-time sales of resale homes, and sales of resale homes between households that are neither entering nor leaving the housing market.

Purchase of new homes

If a household raises a loan to buy a new home, it is reasonable to assume that households' total gross debt will increase correspondingly. This is because the seller is not normally another household that can use the sales sum to repay debt. For a given house price level, growth in the housing stock will therefore result in an increase in gross household debt. An increase in prices for new dwellings will further increase this debt.

First-time purchases and last-time sales of resale homes

When a household enters the resale home market, another household will of necessity have to leave it. This household will free up resources. If the withdrawn equity is used for purposes other than repaying debt, total gross household debt will increase if the buyer debt-finances part of the purchase. If some of the withdrawn equity is used to repay debt, the total gross debt will increase if the increase in the buyer's debt is larger than the reduction in the seller's debt. A household that leaves the housing market will normally have entered the market a number of years previously. The residual housing loan will therefore normally be smaller than the loan of the first-time buyer. Hence total gross debt will increase when the house is sold.

What happens to debt if the price of resale homes rises? We consider a first-time buyer who entirely loan-finances the purchase of a resale home. If house prices increase, it will require a larger loan to buy the dwelling than the previous time it was sold. The price increase will therefore contribute to increasing the buyer's debt. The more house prices increase, the more resources a household that leaves the resale home market will free up. However, the household's debt is not affected by the fact that the dwelling has gained in value. The price increase will therefore result in an increase in the gross debt of households as a whole.

Sales between households that neither enter nor leave the resale home market

We consider a situation in which only resale homes are sold, and none of the households either enter or leave the resale home market. Some households wish to purchase a dwelling that is larger (and more expensive) than the one they own. In order for them to be able to do this, other households must want to buy a smaller (and less expensive) dwelling. We consider a situation with constant house prices. Households that purchase a more expensive dwelling, sell their old dwelling and finance the difference by means of a loan. Those buying a less expensive dwelling will tree up resources. If the mortgage equity they withdraw is used in its entirety to repay debt, total gross debt will remain unchanged. However, debt will increase if part of the withdrawn equity is spent on consumption.

What happens to debt if house prices increase in this case? Assume that house prices increase by 10 per cent per square metre. If a given extra number of square metres are purchased, the price per dwelling will also increase by 10 per cent. The debt of those loan-financing some of the difference will increase accordingly. Those purchasing a smaller, less expensive dwelling, will free up more resources than before the price increase. Their debt will not be affected, however. The price increase will therefore result in higher gross debt for households as a whole. The less the freed up resources used to repay debt, the greater the increase in gross debt.

The significance of house sales

The examples...

To continue reading