Prudential measures in housing access: Should one include transport costs in the front-end ratio?

Abstract

A widespread prudential measure limits the housing expense ratio—defined as the share of income spent on the rent or loan payment—to ensure household solvency. This policy is increasingly criticized, however, as it would induce households to settle far from the city center in search of lower housing prices, fostering urban sprawl. It would even prove counterproductive as high transport costs in distant areas would more than offset the lower housing costs. To avoid these unintended effects, several researchers advocate limiting the joint housing plus transport expense ratio instead. This paper aims to shed light on this issue by comparing the two prudential measures—limiting either the housing or the housing plus transport expense ratio—using the monocentric model. By constraining residential choices and reducing housing consumption, both policies improve household solvency and reduce urban sprawl. While this seems to contradict previous claims, the joint constraint proves more efficient in both regards. Provided the constraint is not too stringent, both policies have limited impact on household welfare and often even improve welfare. But this time, capping only the housing expense ratio always dominates the joint housing plus transport constraint. A numerical application to the Paris region illustrates our findings for a real case study. Results suggest that replacing the current limitation of the housing expense ratio with a joint housing plus transport constraint would significantly improve household solvency and curb urban sprawl, with a negligible welfare loss.