Housing and Income Contingent Loans for Low

Income Households
Joshua S. Gans and Stephen P. King
University of Melbourne
December 2003

1 Introduction

Home ownership is a major goal for many Australian households. For

households that have low, irregular incomes, however, home ownership and
even adequate rental accommodation may be unachievable. In this chapter, we
consider the housing problems facing low income households and how these
households might be helped though a system of income contingent loans (ICL)
that provide a type of insurance for housing. We call this ICL system a ‘housing
lifeline.’
Australia has one of the world’s highest levels of home ownership. In
1999-2000, there were around 7.2 million households in Australia.
Approximately 70 per cent of these households lived in their own home while 26
per cent rented accommodation. In contrast, current home ownership rates are
approximately 69 per cent in the United Kingdom and 67 per cent in the United
States, but are only approximately 41 per cent and 51 per cent for Germany and
Netherlands respectively (Productivity Commission, 2003, p.29).
Further, by international standards, a large proportion of Australian home
owners – almost 90 per cent – live in stand-alone or separate houses. In this
sense, the quality of home that is owned by most Australian households is high
compared to countries where apartment living is the norm.
Traditionally, however, many low income households in Australia have
been excluded from home ownership and rely on the rental market for their
housing needs. Further, these low income households are more likely to be
dependent on government housing. To give an example, if we consider
households comprising an adult couple with children, approximately 79 per cent
own their own house and only 20 per cent are renting. Conversely, for one-
parent households, only 49 per cent are home owners, 30 per cent rent from
private landlords while 17 per cent rent from State or Territory Housing
Authorities.1 Of all renters, approximately one quarter rely on housing provided
by a State or Territory Housing Authority
For both owners with a mortgage and renters, housing costs Australia-
wide come to approximately 20 per cent of gross income. But housing costs as a
percentage of income vary significantly between geographic locations and
between households. In particular, low income households may find adequate
housing unaffordable, particularly in high-cost areas of Australia such as Sydney
and Melbourne.
Housing affordability for low income households may be exacerbated or
assisted by the interaction between different markets for housing and between
housing and associated markets. As noted by Rothenberg et.al. (1991, p.3),
“[h]ousing is not … a single commodity but a complex of variously related
commodities; the urban housing market is not one perfect market but a set of
interrelated submarkets.” Housing differs substantially in terms of quality
between inner city apartments, affluent separate dwellings and outer urban
public housing. For many households, housing is also a major investment asset.
Indeed a house is the single largest asset most households will ever purchase.
Housing markets are inextricably linked with each other. As new high
quality dwellings are built and purchased by the most affluent households,
lower quality housing becomes more affordable for purchase by lower income
households through a type of ‘trickle down’ process referred to as ‘filtering’. The
rental market and the market for home ownership are similarly connected
through factors of supply and demand. For example, the construction and
purchase of inner city apartments in Sydney, Melbourne and Brisbane for
investment purposes has driven the rental returns on these apartments down to
approximately 3 percent in 2003 (Productivity Commission, 2003, p.21).
Housing markets are also tied in with financial markets. Most households
require borrowed funds to buy a house and the lack of availability of mortgage
funds can limit the housing options for low income households.
In order to design government policies to appropriately assist low income
households with their housing needs, it is important to understand both the
drivers of housing affordability and the linkages between housing markets and
related markets. In this chapter we will argue that government policies towards
low income housing have often been geared towards households with a long
term income problem. In other words, governments and welfare groups have
concentrated on households that face long term affordability problems for
housing. An obvious solution for households facing a long term problem of

1The statistics referred to here are from the Australian Bureau of Statistics 2003 Year Book
Australia.

1
housing affordability is for the government to provide on-going rent assistance
for these households, or for the government to directly provide housing for these
households. As we note below, such policies have been widely adopted in
Australia and overseas.
While some low income households are well served by these policies, they
fail to address the needs of households who face a short-term income crisis. We
argue that these households can be better served through a system of income
contingent loans. As we explain below, this ‘housing lifeline’ would not simply
provide ex post protection for low income households but would also increase ex
ante accessibility to housing and related financial markets for low income
households. A system of income contingent loans for housing reduces risk for
both the buyers and providers of housing services and helps to eliminate the
undesirable consequences of asymmetric information in housing markets.

2 Housing Affordability

Low income households face a housing crisis if adequate housing is

unaffordable. In Australia, the past decade has seen low interest rates, low
unemployment and a relatively stable macroeconomic climate. These factors
have resulted in a significant rise in the price of (owned) houses. Australian
Bureau of Statistics figures show that over the three years from July 1998 to June
2001 the weighted average price of existing dwellings in Australia’s capital cities
rose by almost 8 per cent per year.2 This increase in housing prices feeds directly
into rental prices, although as noted above the rental market, for example in
inner Melbourne and Sydney, has been complicated by a significant growth in
apartment stocks in recent years.
While the increase in housing prices reflects general prosperity in
Australia, this prosperity has not necessarily been evenly distributed over the
population. In particular, a rise in general house prices can lower the
affordability of housing to those households who are dependent on low incomes.
Housing affordability is often defined relative to household income. For
example, the National Housing Strategy (Department of Community Services
and Health, 1991) considered housing to be affordable if “housing costs … leave
households with a sufficient income to meet other basic needs such as food,

2 Australian Bureau of Statistics (2002) Yearbook of Australia 2002: Housing prices. At the same time
it must be recognised that changing house prices are closely tied to regional factors, particularly
outside Australia’s urban regions. Thus some country areas have experienced huge rises in house
prices in recent years (e.g. North coast NSW) while other rural areas have seen house prices fall.

2
clothing, transport, medical care and education.” Under this definition, if a
household is spending more than 25 percent (for rent) to 30 percent (for
mortgage repayments) of its income on housing, then that household is
experiencing an affordability problem.
Of course, this type of definition of affordability could apply to high
income households who spend a lot on housing. Thus, this benchmark on
affordability is usually only applied to households that fall into the bottom 40
percent of the overall distribution of income. In Australia, in 2001, the
affordability threshold based on 30% of the second quintile of average weekly
household income was only $141 compared with the median weekly rent in
Australia of $183 and a median weekly mortgage repayment of $230.3 Berry and
Hall (2001) determined that the proportion of private tenants in the bottom 40%
of the overall distribution of income paying more than 30% of household income
on rent is around 70% Australia-wide, with an even higher rate in Melbourne
and Sydney.
A definition of housing affordability that considers housing costs as a
proportion of income does not allow us to easily distinguish between a housing
problem and a low income problem per se. Low income households could be
experiencing problems with housing affordability for two alternative reasons.
The first is that these households, because of their low income, are finding many
of the essentials for daily life to be unaffordable, including housing, food, and
clothing. Thus, their income is low relative to the general cost of living in society
and these households have an income problem rather than a specific housing
problem. Alternatively, low income households may be finding it hard to make
ends meet because housing, as a specific commodity, is highly priced relative to
other essentials and as a result housing eats up much of the household’s
disposable income. Such a family has a problem of housing affordability.
To separate between issues of housing affordability and issues of general
affordability, Glaeser and Gyourko (2002) adopt an alternative approach. They
argue that a housing affordability problem arises when housing is expensive
relative to its fundamental costs of production, including construction, taxation
and regulatory costs. For this reason, they advocate using a benchmark of the
physical costs of constructing a house as a means of determining whether and
where housing is too expensive.
If we believe that there is a housing crisis, then presumably the
correct housing response will be to build more housing.
However, the social cost of that new housing can never be lower
than the cost of construction. As such, for there to be a “social
gain” from new construction it must be the case that housing is

3 ABS figures presented in HIA (2003).

3
 priced appreciably above the cost of new construction. (Glaeser
and Gyourko, 2002, p.2)
Using this approach we can gain a sense of the affordability problem by
comparing housing prices in a particular area to the construction costs in that
areas.
As can be seen from Figure 2, house prices have increased at a faster rate
than the cost of building materials in Sydney. A similar pattern is evident in
Melbourne in relation to house prices and construction costs in general (Figure
3). In other capital cities, a divergence between house price increases and
construction costs is a relatively recent phenomenon (occurring in the last two
years or so).

Figure 2: Sydney House Prices and Building Materials Costs

Sydney house prices vs house materials prices

250

200
Price indices (1989-1990 = 100)

150

House building materials costs Sydney

House prices Sydney

100

50

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Source: ABS Data

4
 Figure 3: Melbourne House Prices and Construction Costs
Melbourne house prices vs house construction costs

250

Price indices (1989-1990 = 100) 200

150

House construction costs Melbourne

House prices Melbourne

100

50

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86

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Source: ABS and Rider Hunt

The potential divergence between construction costs and overall house

prices can be seen from the following table reproduced from the Australian
Consumer Association (2003). In this table, “project houses” include the costs of
housing without land while “established homes” include both land and house
prices as a package. Both categories are for freestanding dwellings only.

Notice that, in Sydney, Melbourne, Brisbane, Perth and Canberra, there is

a growing divergence between construction costs and house prices. This is not
evident in other cities. Indeed, in Hobart and Darwin, there is a trend in the

5
opposite direction; suggesting an improvement in housing affordability in those
cities.

3 Government housing policies for low income

households

To the extent that housing affordability, particularly for low income

households, has fallen in a range of Australian cities, there is scope for
government assistance to low income households. Roughly speaking, these
government policies can be classified as either supply-side responses or demand-
side responses.

3.1 Supply-Side Policies

Supply-side policies around the world typically comprise a variety of

public housing projects and developments. In Australia, the bulk of public funds
for housing development come through the Commonwealth-State Housing
Agreement. This agreement involves capital grants to State Housing Authorities
who in turn provide public housing and direct aid to community housing
organisations for social housing. These payments also fund crisis
accommodation, and loans and grants to private investors to offset initial costs.
In the past, United States housing policies have had a similar thrust. In
recent years, however, there has been a move away from supply-side to demand-
side policies (Quigley, 2000).
In Britain, there is a long tradition of state provided public housing;
usually managed by local councils. This policy has undergone a revolution in the
last two decades with strong moves towards owner-occupier solutions and
private sector ownership. This has been achieved primarily by substitution of
government funds for demand-side policies.
In the Netherlands, a significant level of housing stock remains in public
hands with management provided by housing associations in a largely
decentralised manner.
A recent major proposal to address low income housing affordability in
Australia commissioned by the Affordable Housing National Research
Consortium (AHNRC) has focussed on a supply-side response. The AHNRC is a
national committee with representatives from the housing, building and
development industries, trade unions and not-for-profit organisations. It
commissioned the Australian Housing and Urban Research Institute (AHURI)

6
and the Allen Consulting Group to undertake an extensive study into the nature
of the affordable housing problem and the options for public policy in this
regard.
Their report (AHURI, 2001) advocated and costed a preferred policy
response that involved:
• Public debt raising. The state and territory governments should
raise debt through a long-term bond issue at market prices to
private investors. Institutional investors were seen as potential
purchasers of these bonds in the current environment of low
public debt in Australia.
• State government acquisition of new and existing dwellings. Housing
authorities in each state (or SHAs) would use the funds to
acquire dwellings.
• Federal government subsidised rent. Those dwellings would be let
out at low rents to eligible tenants. This will mean that the
returns on the government dwellings will be insufficient to
cover the bond financing costs (as these are at market rates) and
the operating costs on the dwellings. The gap would need to be
covered by the Federal government for the life of the program.
• Progressive sale. The dwellings would not remain in public
hands indefinitely but would be progressively sold off when
they fell vacant. The sale would be used to repay debt.
• Sunset. Those dwellings still in government hands at the end of
20 years would be sold and the remaining debt would be
retired. Sitting tenants at that time would have to be relocated.
Of course, it is also possible that an SHA may decide to retain
this stock in public hands. In this case, state governments would
be required to bear subsidy costs.
The Consortium argues that this program is cost effective for the Federal
government because for each dollar in subsidy, $4.50 in housing can be acquired
– that is, $3.50 comes from private investors. This is compared to the alternative
where all $4.50 comes directly from the Federal government.
It is argued by the Consortium that this approach involves a public-
private partnership and brings new private funds into public housing. Such a
claim, however, is simply an illusion of accounting. Government expenditures on
housing can and always have been met by a combination of taxation and
government debt. The Consortium is arguing for an increase in debt rather than
taxation to fund public housing. They compare this to the alternative where
public housing is funded totally out of taxation revenues. As Berry (2002, p.9)
notes: “the Consortium model reinvents public borrowing for social housing.”

7
 The AHURI proposal suffers from the presumption that those households
who are not adequately served by an unfettered private housing market must be
removed completely from this market. Such a presumption leads to a policy
where public housing is financed, owned and managed by the government. The
fallacy underlying this presumption was noted by the great urban activist Jane
Jacobs. When considering the housing needs of low income households, she
notes that “these are people whose housing needs are not in themselves peculiar
and thus outside the ordinary province and capability of private enterprise, like
the housing needs of prisoners, sailors at sea or the insane. Perfectly ordinary
housing needs can be provided for almost anybody by private enterprise. What
is peculiar about these people is merely that they cannot pay for it” (Jacobs, 1961,
323-324; italics in original).
Inadequate private provision and allocation of housing does not
necessitate public provision and allocation of housing (e.g. Olsen, 2001). Further,
public provision and allocation of housing necessarily ignores significant aspects
of individual tastes and preferences. In other words, public housing, while
attempting to solve a failure of the private market, also neglects the benefits of
housing allocation associated with the private market. It replaces individual and
household choice with some form of bureaucratic decision making.

3.2 Demand-Side Policies

While supply-side policies focus on government provision of housing,

demand-side policies assist households to gain suitable housing through the
private market. Thus, demand-side policies involve less micro-management than
supply-side policies and provide greater discretion to the recipient households.
A common policy, both in Australia and overseas, is to provide low
income households with rent subsidies. This type of policy has many forms,
including subsidies paid directly to low income private tenants and direct
payments to landlords to ‘compensate’ for the provision of housing to low
income households. The calculation of the relevant subsidies, eligibility criteria,
specificity of the payments and mode of payment differ widely between
jurisdictions.
In the United States, part of the Section 8 voucher program provides
subsidies for low income households who choose to live in a certain minimum
standard of accommodation. The subsidy covers the difference between 30
percent of the household’s income and a defined ‘fair market rent.’ The scheme is
administered through a local public housing authority which determines the ‘fair
rent’ for the unit. The relevant household, once they rise to the top of a waiting

8
list, can search for any dwelling that satisfies the programs requirements.4 The
public housing authority then pays the subsidy directly to the landlord on behalf
of the tenants. The tenants pay the difference between the subsidy and the actual
rent of the dwelling. Eligibility for the program is geographically based, with
relevant households having less than 50 per cent of the median income for the
relevant area.
In Australia, a similar type of rental assistance is available, for example to
individuals who receive a government pension or to households with dependent
children who satisfy relevant criteria under the family tax benefit scheme.
Payments are made to households who rent a dwelling from a private landlord
and the payment is made to the household in addition to the other benefit
payments being received by the household.5 Rent assistance is calculated at three
quarters of the rent being paid by the household above a minimum threshold, up
to a maximum payment. For example, for a family with a single adult and one or
two dependent children, the maximum payment in 2003 was $109.48 per
fortnight. Rent assistance only applied if your rental bill was at least $109.06 per
fortnight and the maximum rent (to receive the maximum payment) was $255.03
per fortnight. The payments do not vary across cities or regions. For this reason,
it targets low nominal income rather than low real income households.
Rental assistance schemes need careful design. Because they tend to be
based on current rather than lifetime income, they can easily lead to poverty
traps for low income households. These programs may be viewed by
governments as a drain on funds, and as the US experience shows, they may
involve funding that only covers some and not all low income households.
Depending on the form of payment and the dwelling criteria, these schemes may
distort dwelling choice. For example, the Australian scheme which has an ad
valorem subsidy effectively reduces the marginal price of housing to low income
households once rent is above the minimum threshold and until it reaches the
maximum. Such a subsidy will tend to push rental demand towards the
maximum thresholds. This can involve households choosing ‘too high’ a level of
housing relative to other inputs of equal or greater importance to family welfare
(e.g. clothing, food, education, child care, etc). It can also lead to ‘bunching’ in the
rental market, where much rental accommodation is offered near the maximum
cut off with a reduction in more moderate housing.
Governments may assist low income households to purchase housing
rather than rent housing through some form of ‘ownership subsidy’. The first

4Demand for the program significantly exceeds the available funds, leading to waiting lists of
applicants.
5 In other words, rent assistance is a supplemental benefit that is only paid to households who are

receiving a primary benefit from the Australian government.

9
home owner scheme in Australia represents on ownership subsidy scheme. It
only applies to first home owners and has very broad eligibility criteria. In this
sense, it does not focus on low income households, although such households
also enjoy the benefits of the scheme.
The U.S. section 8 program includes vouchers for first home owners. Like
the rental vouchers program, it is administered through public housing
authorities and has minimum quality requirements for the dwelling. The scheme
has minimum and maximum income criteria and also an employment criterion.
It is generally only available to first home owners. This said, there is no separate
funding for this home ownership scheme. Public housing authorities who
participate in the scheme must draw funding from other voucher arrangements
and authorities do not have to participate in the scheme.
Governments may also use the tax system to implement demand-side
housing policies. In the US, the Low-Income Housing Tax Credit programme
provides tax relief for investors in long-term low income housing. There is
certainly scope, therefore, for governments to use tax relief to encourage
investment in housing for particular types of households. However, the scope for
tax relief to low income households themselves is limited by the fact that those
households usually do not incur significant levels of tax relative to housing costs.
A number of alternative demand-side policies have recently been mooted
in Australia. Gavin Wood (2001) formulated a proposal that is similar to the US
low-income housing tax credit. He proposed two reforms to the tax system:
• Income tax credit. Investors with dwellings that have rents below
a certain threshold (Wood considers $100 per week), would
receive tax credits.
• Capital gains tax reform. There would be relief from capital gains
tax on the first $10,000 of capital gain for these dwellings.
As formulated by Wood, this policy would be an entitlement to any
investor at the lower end of rental accommodation. The policy, at its heart, is a
government subsidy, albeit that it is organised in a non-transparent way through
reductions in taxation payments. The policy also raises issues of accountability
relating to length of low income tenancy, the legitimacy of tenants and the nature
of the dwelling. The policy may lead to the inappropriate downgrading and
degradation of some housing stock, in order to meet the program requirements.6

6 As a simple example, an investor seeking to gain the benefits of the scheme could take a single

dwelling, rented at $200 per week, and divide it into two dwellings, each rented at $100 per
week. At one extreme, this may simply be done as an accounting trick – without even a change in
tenants. At the other extreme, where each dwelling requires specific individual features, the
division may involve costly (and possibly inappropriate) modifications to the dwelling that
reduces its utility for housing.

10
Such a scheme would need to be carefully designed to prevent gaming by
investors.
Caplin and Joye (2002) discuss the possibility of using shared equity
schemes to increase housing affordability. Under this system, a lender, such as a
bank, would retain an equity interest in a dwelling, reducing the amount of
capital required to be borrowed by a household seeking to buy the property. A
household would then be able to ‘balance’ its debt and equity exposure to the
housing market, much as commercial businesses manage their mix of debt and
equity financing.
While a shared equity scheme may assist to improve overall housing
affordability, it is not geared to low income households. As we discuss below,
many of these households face significant problems when attempting to access
traditional financial or rental markets, so that a share equity scheme by itself may
do little to benefit low income households.

4 Low Income Households and Market Failure

The government policies discussed above tend to focus on longer term

solutions to housing affordability for low income households. In other words, the
policies are geared towards households who not only have current low income
but are likely to continue to have low income for the foreseeable future.
However, housing affordability is often a problem for low income
households due to temporary distress. A low income family might find housing
affordable most of the time, but can remain vulnerable to income shocks that
make housing unaffordable for short periods of time. For example, consider a
low income family whose main income earners often experience short spells of
unemployment. This may reflect the nature of the jobs held by family members.
While over the households ‘life cycle’ it might have adequate income for
housing, at particularly stages of that life cycle, housing may be temporarily
unaffordable. For example, housing stress may occur when children are young,
particularly if this coincides with a period of unemployment for an income
earner.
Similarly, low income households may be adversely but temporarily hit
by short term income shocks, for example due to illness or accident. These shocks
may make housing unaffordable in the short term. Government policies aimed at
long-term housing relief, particularly those policies that involve moving to
particular dwellings, will often be inappropriate in these circumstances. Indeed,
to the degree that a household must ‘lose’ its current housing before it can
receive government assistance or faces high effective marginal tax rates once

11
government assistance is accessed, government policies may inadvertently
change short-term housing distress into a long-term affordability problem.
In theory, financial markets should be able to deal with problems of short-
term loss of income. However, it is well understood that financial markets suffer
from potential problems of asymmetric information that may lead to market
failures such as credit rationing.7 These market failures will fall most heavily on
low income households.
Credit rationing arises due to adverse selection problems in financial
markets. Potential lenders may have difficulty distinguishing between
individuals who would be able to make repayments and those who cannot. As a
result, potential lenders may be reluctant to provide funds to customers who
appear more risky; for example individuals with a lack of credit history or who
are proposing more risky investments.
This problem of asymmetric information is different to a problem of risk.
After all, risk accompanies all lending and, in the absence of information
asymmetries, more risky borrowers would simply face higher interest rates than
less risky borrowers. Rather, the problem is that the potential lender cannot
adequately distinguish between high and low risk borrowers and so may be
reluctant to lend any funds. Further, this problem cannot be solved by simply
raising the interest rate on borrowed funds. Raising interest rates may simply act
to dissuade the low risk borrowers leaving only the high risk borrowers. After
all, the high risk borrowers, who know that there is a higher chance they might
default on the loan, will be less influenced by interest rates. In this way, a simple
interest rate charged equally to all potential borrowers, adversely selects for
borrowers with a higher risk profile. To attempt to solve this problem a lender
might try to ration credit; attempting to infer borrower risk through indirect
means.
In the financial markets that provide loans for purchasing housing, a
number of standard tools have developed to deal with adverse selection. Lenders
often ration credit on the basis of income history and income potential.
Borrowers who have a steady history of income earnings or who are trained and
employed in ‘stable’ professions are more likely to receive funds than potential
borrowers with variable income histories or who are employed in less stable
industries. This clearly has an undesirable effect on low income households,
particularly those with a chequered history of employment. Such households
will tend to be excluded from access to housing finance.
Lenders may also deal with adverse selection by shifting risk back onto
the borrower. This is most easily achieved by requiring a large deposit on a

7 See, for example, Stiglitz and Weiss (1981).

12
house before funds are provided. This reduces the risk that the financier will be
stuck with a house that is valued at less than outstanding debt if default occurs.
But again, low income households will be most adversely affected by this
solution, as they are least able to save for a significant housing deposit while at
the same time paying for rental housing.
Lenders can also shift risk onto a third party, requiring potential
borrowers to have a third party guarantee the loan. Again, low income
households are adversely affected by this solution as they are less likely to have
‘richer’ family members or friends who can act as guarantors.
Overall, we would expect that asymmetric information in housing finance
markets will impact most heavily on low income households, limiting their
access to housing finance.
Similar adverse selection problems arise in rental markets. Investors are
keen to rent properties to households or individuals who will be able to pay the
relevant rent and who will minimise depreciation of the dwelling. But landlords
cannot tell the exact risk associated with particular tenants and will try to infer
this risk from other factors. Again, an obvious method used by landlords to
distinguish between tenants is their employment history and their current job
and income. This discriminates against low income households who are viewed
as having a higher risk by landlords.
Other common methods that have historically been used by landlords to
vet tenants include the marital status of potential tenants, whether the household
includes children and the number of adults in the household. While explicit use
of these types of characteristics would violate current anti-discrimination laws in
Australia, landlords will still be tempted to try and infer tenant risk from
information they can gain about the tenant. This makes the rental prospects for
low income households less certain than those for higher income households.
The use of economic discrimination in both financial and rental markets
biases those markets against low income earners. This discrimination need not
reflect any bias on the part of lenders or landlords. Rather it is simply a rational
attempt by lenders and landlords to at least partially overcome information
asymmetries in these markets. However, the end result may be to ration many
low income households out of the private markets for housing. Put simply, the
market imperfections can make housing unobtainable for low income
households.
The problems of adverse selection relate not only to low income per se but
also to income risk. If a potential borrower has inadequate income to cover
repayments, then that borrower will not be lent the funds to buy a house.
However, even if a potential borrower is likely to have adequate funds on average
to cover a home loan, if that household’s income is variable then the probability
of default is higher and they may also be able to access housing funds.

13
 Income risk is something that faces all households. It can arise through a
number of sources. For example, unemployment is usually associated with a
significant but temporary drop in income for individuals and households. Injury
or significant illness can also lead to a sudden reduction in income.
An unforeseen drop in income can lead to a large but temporary reduction
in housing affordability for the relevant household. For example, if the
household is renting, then it may be impossible for the household to make its
regular rental payments when it suffers a sudden reduction in income. In such
circumstances, the household faces eviction. Similarly, recurring mortgage
payments may not be met due to a sudden income shock, leading to potential
foreclosure.
Income risk, like any other form of risk, can be reduced by insurance. For
example, income protection insurance is available to households. Similarly, both
landlords and lenders may be willing to renegotiate agreements to overcome
short-term income shocks. After all, finding new tenants or foreclosing on a
mortgage and selling a property are both expensive activities. Both landlords and
lenders have incentives to take actions to avoid incurring these expenses. Finally,
households may self-insure against income risk, for example by keeping ahead of
mortgage payments or by keeping a readily accessible pool of savings.
These solutions to reduce the cost of income risk, however, are less likely
to be available to low income households. For a household with a history of
unemployment, income protection insurance is likely to be either unavailable or
prohibitively expensive. The moral hazard problem facing the insurer makes
such insurance unviable. Self-insurance through discretionary saving is difficult,
if not impossible, for low income earners. And renegotiation to avoid foreclosure
or eviction is less likely to occur for higher risk, marginal households.
Consequently, low income households are likely to face significant
residual income risk that creates short-term housing crises for these households.
Government housing policies are not geared towards dealing with income risk
and short term crisis. For example, Federal government rental assistance in
Australia only becomes relevant once a household becomes eligible for other
forms of benefits. In the US, Section 8 voucher programs often involve waiting
lists, meaning that they are unable to meet the needs of low income households
facing short term distress. As a result, existing policies only tackle part of the
problem of low income housing.

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5 The Housing Lifeline

If existing government policies geared at low income households housing

needs are inappropriate to deal with income risk, what should be done? One
approach, first considered in Gans and King (2003) involves the use of income
contingent loans by the government to help households overcome short term
income fluctuations. This ICL scheme aims to increase access to financial and
rental markets for low income households, by limiting the undesirable
consequences of adverse selection on landlords and lenders. It also aims to help
protect low income households from the adverse housing consequences of a
short-term income shock.
The Housing Lifeline involves governments addressing the income risk
associated with low income households directly. The government would provide
a form of income insurance to low income households, to ensure that short term
income fluctuations do not create long term housing problems. For example, the
government might allow a household that has suffered a short-term drop in
income, due to say unemployment or temporary lay off, to draw down a
payment (say up to an eventual maximum of $5,000 - $10,000) towards rental or
mortgage costs. The funds would form an ICL for the household. In other words,
a low income household that chooses to draw down on the housing lifeline is not
receiving gift from the government but faces a liability for future payment.
However, this future payment is related to future income, further insuring the
household and avoiding long term poverty traps.
To see how a housing lifeline would work in practice, suppose that a
household suddenly finds itself facing a crisis where it is likely to be unable to
meet short-term commitments for housing payments. A housing lifeline means
that the household would be able to draw down a payment from the federal
government to tide it over the short-term crisis. This payment would be a loan to
the household, but the loan would be automatic. In other words, the household
would face few if any hurdles – perhaps no more than a simple liquid asset test –
in the short-term when accessing the lifeline funds. However, the household
would incur a future tax liability associated with the loan. In other words, the
lifeline is an income contingent loan. The liability may or may not have a
reduced interest rate associated with it, depending on government policy. For
example, to limit long term government exposure to lifeline debt, the lifeline
interest rate might be set equal to the long-term government bond rate. This is
likely to be substantially below equivalent interest rates available to low income
households.
Payments to a household would be capped. The housing lifeline is
designed to provide short-term relief, not to provide a permanent source of
support for those households who will not have the means to adequately fund

15
housing in the medium to long-term. Thus, while the lifeline might displace
other programs such as rental assistance in the short term, it does not replace
other long-term welfare programs but supplements these programs by providing
more appropriate short-term assistance to low income households facing
temporary crisis. The payments may be capped on both a weekly and a total
basis. For example, it might be possible to ‘borrow’ up to $200 per week under
the cap up to a total of $10,000. Thus, the scheme would provide up to 50 weeks
(or more if less than $200 was drawn upon) support for a relevant household.8
The payments under a housing lifeline would be tied to housing. Thus,
funds would be paid directly to a (registered) landlord or lender specified by the
relevant household. This would require a contractual agreement that ensures
that the funds do reduce the household’s liability to landlords and lenders
directly. At present, Medicare payments operate in this manner.
Drawing down the lifeline would be a choice made by the relevant
household. But because this access to an instant ‘line of credit’ removes a
substantial amount of the risk that would otherwise face lenders and landlords
who provide housing solutions to low income households, the lifeline directly
addresses the problems embedded in the rental and mortgage markets. Thus,
while the lifeline is designed to provide short term housing insurance for low
income households and as such is drawn down after a crisis occurs, this
insurance will increase the ability of low income households to access housing
markets. It removes some of the problems of adverse selection that otherwise
face lenders and landlords.
The risk, of course, does not disappear, but it is both reduced and it is
passed onto the government. The risk is reduced because the government takes
on a portfolio of ‘loans’ to low income households. Unlike an investor with only
one or two properties, the government can pool the risk of income loss for low
income households, reducing the idiosyncratic variability of that risk.
Passing the risk onto the government also has important economic
advantages. In particular, unlike a private lender or landlord, the government
has the substantial advantage of ensuring appropriate repayment of any lifeline
loan through the taxation system. In this sense, an ICL provided by the
government involves a lower repayment risk than an equivalent private loan.
Further, the government potentially saves some welfare expenditure
through the housing lifeline. Most obviously, to the degree that a household is
able to draw down the lifeline so that the household is less reliant on other

8Even low income households who face a crisis due to unemployment usually find new work
within six months. Thus, any household who remained in crisis after twelve months should
probably be moved to a more permanent program.

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government assistance, the lifeline reduces demand for short term government
assistance. More importantly, by reducing the adverse consequences of a short
term income shock, the lifeline should help low income households from sinking
into long term poverty.
In theory the housing lifeline could be substantially self-funding. So long
as the interest rate charged by the government is above the long-term bond rate
on government funds and accumulated debt is eventually repaid, the
government will be operating on the same funding principles as any lender.
In practice, of course, full repayment from every household will not be
possible. Some households will move from temporary to long-term crisis and
will be unlikely to ever gain a lifetime income that would allow repayment. In
such a situation, the household can be transferred onto appropriate long-term
benefits after the lifeline expires or when the long-term nature of the crisis
becomes evident.
At the same time, it must be recognised that the housing lifeline will help
low income households who face short-term crisis from becoming dependent on
long term welfare. In this sense, the lifeline could be highly cost effective for the
government even if it does not cover its own cost because it avoids the
government paying other benefits over a longer period of time.
To see this consider a low income household suddenly faced with an
income crisis. The household may face eviction or foreclosure. This may force
them to move to alternative housing in the short-term and may force them to
move onto government benefits. In the medium-term, the crisis will harm the
household’s credit standing so that it may be harder for the household to gain
appropriate housing in the future. Thus, the temporary income crisis may lead to
a long-term housing crisis for the household. The timely and temporary
intervention allowed by the lifeline can avoid these long-term problems (with the
associated long-term government payment of benefits).
The government might also choose to subsidise the lifeline interest rate.
While this raises the cost of the lifeline it also creates greater protection for low
income households by limiting their lifeline debt exposure.
Implementing a housing lifeline obviously requires policy makers to
address a number of important practical issues. For example, it is important to
determine both the weekly draw down available under the lifeline and the
maximum debt level available under the lifeline. For example, a weekly loan of
around the level of current rent assistance, say $200 to $250 per week, might be
appropriate under the life line. Unlike rent assistance, the lifeline would be
automatic so that households would not be required pass eligibility waiting
periods as is required currently under rent assistance. Alternatively, it might be
felt that a slightly higher weekly draw down should be possible under the
lifeline. After all, the lifeline is a loan, not an entitlement.

17
 The maximum length of the lifeline might be twelve months. The lifeline
is designed to deal with short term stress and it is reasonable that a household
that still faces an income crisis after one year requires longer term assistance.
As with all government programs, the rules of the lifeline need to be
carefully designed to avoid people ‘rorting’ the system. This involves issues such
as potential adjustments for the number of people in the household (in
particular, the number of dependents) and for different household
configurations. These issues, however, must also be dealt with under the existing
social security and taxation system. Lessons from these schemes can be used to
implement the housing lifeline.
In summary, the housing lifeline provides a powerful tool to protect low
income households against income shocks and potential housing loss. In so
doing, the lifeline opens up financial and rental markets to low income
households. Unlike alternative welfare systems it avoids creating a poverty trap
by treating payments as a loan rather than an entitlement that is ‘lost’ as income
rises. Thus, a housing lifeline can retain incentives for households to take
appropriate actions and risks to improve their standard of living.

6 Critiques of the Lifeline

Since the lifeline was originally proposed in Gans and King (2003) it has
raised significant feedback from those interested in low income housing issues.
While much of the feedback has been positive, some has raised questions about
the usefulness of a housing lifeline. A number of these criticisms are summarised
in Productivity Commission (2003, p.153-4). In this section, we briefly consider
some of the issues that have been raised regarding the lifeline.
One immediate question that arises with the lifeline relates to private
sector financial institutions. Isn’t the housing lifeline something that could be
done by private financial institutions? Why can’t banks and other lenders
provide temporary loans to households in crisis? This question however misses
the underlying rationale of the lifeline, which is to overcome private sector
market failure. Banks cannot easily distinguish between households who face
short and long-term housing crises. As they do not wish to manage the risks of
loan default, they naturally shy away from lending to households precisely when
they might need a loan most.
The government, however, already bears the risk associated with long-
term housing crises. Therefore, while it faces funding issues associated with
managing its own debt, this is not related to the particular, unknowable status of
a particular household. It also has the ability to use the tax system to monitor

18
income and repayments. In this respect, the government is in a better position
than private lenders to provide a ‘no questions asked’ lifeline to households in
crisis. They can assist those households for which the crisis is short-lived while
continuing to assist those with long-term needs.
A second critique is that the housing lifeline will encourage excessive
home ownership, by reducing the risks associated with taking out a home
mortgage. With the lifeline, households face a reduced risk of default because of
a short-term inability to meet repayments. For lenders, this reduced risk of
default will change the criterion upon which they can accept loans from low
income households. In this respect, it will improve access to credit.
However, the lifeline does not explicitly encourage home ownership over
renting. The lifeline payments will apply equally to owners and renters. Thus,
landlords will face lower risks of non-paying tenants and hence, there will be
improved access to rental properties for low income housing. The lifeline is
designed to make housing more affordable regardless of whether housing is
owner-occupied or not.
A third critique is the exact opposite of the second. The lifeline is not
appropriate because it does not encourage greater home ownership. For
example, it does not directly address the ‘deposit gap’ faced by low income
households.
We agree that the housing lifeline does not artificially bias low income
households towards home ownership as opposed to rental accommodation.
Indeed, it is far from obvious to us that such a bias would be desirable although
this type of ‘ownership bias’ seems to underpin much recent concern over
housing affordability more generally. However, the criticism also fails to
understand the private sector issues that drive affordability problems for low
income households. To see this, ask a simple follow up question – why does the
‘deposit gap’ exist? As noted above, increasing deposit requirements is one way
that private sector financial institutions can attempt to overcome asymmetric
information. A deposit requirement both reduces bank risk and signals the bank
that the borrower can save a reasonable sum of money at the same time as paying
rent. In other words, the deposit requirement is designed to weed out high-risk
low-income households as potential borrowers. It does this by weeding out all
low-income households! A policy, such as a ‘home owner’s grant’ that attempts
to directly address the ‘deposit gap’ in fact fails to address the underlying market
failure that drives this gap in the first place. In contrast, the lifeline is clearly
designed to address the market failure in private financial markets. It solves the
underlying problem rather than acting as a band aid solution.
Finally, it has been noted that households use a variety of strategies to
guard against periods of income stress, such as saving and income insurance.
This is of course true, but again fails to consider low income households

19
specifically. As already discussed, these households are unlikely to be able to
buy appropriate income insurance and will not be able to ‘self insure’ through
saving. Indeed, if taken seriously, this criticism could be used against all
government welfare policies. After all, why have unemployment benefits when
households can save to protect themselves in periods of unemployment? Why
have government provided health insurance when we could all rely on private
insurance?
In fact, the criticism that government intervention is not needed misses the
point. The housing lifeline is not aimed at protecting the well off but rather aims
to help the least well of in society. The fact that the well off have other private
options available to them is good, and we would encourage the use of those
options. But this does not mean that low income households can be ignored by
the government. The housing lifeline helps low income households.

References

AHURI (2001), “Policy Options for Stimulating Private Sector Investment in

Affordable Housing Across Australia,” Stages 1 to 4, Working Papers,
Australian Housing and Urban Research Institute.
Australian Consumer Association (2003) Submission to Prime Ministers Home
Ownership Taskforce, Canberra.
Berry, M. (2002), “Affordable Housing Project: Background Paper,” mimeo.,
CEDA.
Berry, M. and J. Hall (2001), Policy options for stimulating private sector investment
in affordable housing across Australia, Stage 1 Report: Establishing the need for
action, Report to Affordable Housing National Research Consortium,
Sydney, February.
Caplin, A. and C. Joye (2002), “A Primer on a Proposal for Global Housing
Finance Reform,” Discussion Paper, Menzies Research Centre, Canberra.
Department of Community Services and Health (1991) National Housing Strategy:
framework for reform, AGPS, Canberra.
Housing Industry Association (2003)
Gans, J. and S. King (2003) “Policy options for housing for low income
households”, Paper prepared for the Prime Minister’s Home Ownership
Taskforce, Canberra.
Glaeser, E.L. and J. Gyourko (2002), “The Impact of Zoning on Housing
Affordability,” Working Paper, No. 8835, NBER.

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Jacobs, J. (1961), The Death and Life of Great American Cities, Vintage: New York.
Olsen, E.O. (2001), “Housing Programs for Low-Income Households,” Working
Paper, No.8208, NBER.
Quigley, J.M. (2000), “A Decent Home: Housing Policy in Perspective,”
Brookings-Wharton Papers on Urban Affairs, 1 (1), pp.1-47.
Productivity Commission (2003) First Home Ownership: Discussion Draft,
Melbourne, December.
Stiglitz, J.E. and A. Weiss (1981), “Credit Rationing in Markets with Imperfect
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