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In: Finance

3. What factors influence home affordability and whether the purchase of a home is realistic? for...

3. What factors influence home affordability and whether the purchase of a home is realistic? for each, provides details as to why it is included on the list.

Solutions

Expert Solution

Main factors that affect the housing market are as follows:-

  • Economic growth. Demand for housing is dependent upon income. With higher economic growth and rising incomes, people will be able to spend more on houses; this will increase demand and push up prices. In fact, demand for housing is often noted to be income elastic (luxury good); rising incomes leading to a bigger % of income being spent on houses. Similarly, in a recession, falling incomes will mean people can’t afford to buy and those who lose their job may fall behind on their mortgage payments and end up with their home repossessed.
  • Unemployment. Related to economic growth is unemployment. When unemployment is rising, fewer people will be able to afford a house. But, even the fear of unemployment may discourage people from entering the property market.
  • Interest rates. Interest rates affect the cost of monthly mortgage payments. A period of high-interest rates will increase cost of mortgage payments and will cause lower demand for buying a house. High-interest rates make renting relatively more attractive compared to buying. Interest rates have a bigger effect if homeowners have large variable mortgages. For example, in 1990-92, the sharp rise in interest rates caused a very steep fall in UK house prices because many homeowners couldn’t afford the rise in interest rates.
  • Consumer confidence. Confidence is important for determining whether people want to take the risk of taking out a mortgage. In particular expectations towards the housing market is important; if people fear house prices could fall, people will defer buying.
  • Mortgage availability. In the boom years of 1996-2006, many banks were very keen to lend mortgages. They allowed people to borrow large income multiples (e.g. five times income). Also, banks required very low deposits (e.g. 100% mortgages). This ease of getting a mortgage meant that demand for housing increased as more people were now able to buy. However, since the credit crunch of 2007, banks and building societies struggled to raise funds for lending on the money markets. Therefore, they have tightened their lending criteria requiring a bigger deposit to buy a house. This has reduced the availability of mortgages and demand fell.
  • Supply. A shortage of supply pushes up prices. Excess supply will cause prices to fall. For example, in the Irish property boom of 1996-2006, an estimated 700,000 new houses were built. When the property market collapsed, the market was left with a fundamental oversupply. Vacancy rates reached 15%, and with supply greater than demand, prices fell. (Irish house prices fall 50%)

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