Purchase or Not Purchase a House, Essay Example

The decision to either purchase or not purchase a house is one of the most important and impactful a person can make. Purchasing a house is the largest transaction many people will make in their lives. Since nearly all houses are bought with some amount of credit, an incorrect decision can be extremely damaging. Someone who pays too much for a house may end up in the unenviable states of foreclosure or negative equity. Due to the long term nature of mortgages, a homebuyer must carefully consider whether they can guarantee being in a secure financial state for the long term.

As economics is a field dedicated to trying to explain the decisions people make with regards to money and goods, its principles must have insights into the process and decision making of home buying. In fact, economics can explain home buying through principles such as the choices presented by unlimited desires and limited resources to fill them. Also, the principles of thinking at the margins, opportunity costs, and responding to incentives are evident in home buying decisions.

A crucial part, if not the most crucial concept, of economics is the idea that human beings desires are endless, but resources are not. According to economics these facts inform all of the decisions we make in life. In regards to home buying this means that nearly all people would prefer the biggest possible house on the biggest property with all possible amenities, such as a pool, a freestanding guest house, and tennis courts. However, society does not have the raw materials to build everyone a house of this size, the space for properties of this size, or the man power to do it. Based on the scarcity and demand for these resources, prices are set which people need to pay to utilize them.

These prices function in a way that limits the amount people can spend on their houses. The theoretical limit would be the entirety of a person’s income, however practically people do not spend their entire income on their houses. This is because of the opportunity cost of that spending. Opportunity cost is what someone must pass up to take one action. A dollar may only be used once, so using it to purchase one thing means a person passed up opportunities to purchase other things of that value. A person may desire as much housing value as they can get, but spending extra money on a house limits the amount they can spend on food, a car, or any other goods. Also, by purchasing a less valuable house a person may be able to work less, enjoying leisure time, another good valued even if difficult to quantify. Therefore people spend as much on their house as they can without depriving themselves of enough money to buy other goods they desire or forcing themselves to work more than their preferences.

The idea of rationality in economics states that rational people will pursue their own self interest. That means that they will try to use their limited resources in a way that maximizes their own happiness. In home buying that means searching for houses that will fulfill specific needs for them. A single person without children searching for a house will not be interested in one with many bedrooms. Theoretically, since sellers will want to supply what buyers demand, this should lead to a housing market that perfectly meets the needs of the buyers. This also relates to the theory or marginal diminishing returns. While shelter may be one of the most pressing needs for people immediately, at some point they have spent enough on shelter and will look to purchase other things. This is due to marginal diminishing returns. The first units of any good will provide more happiness than the second, which will provide more happiness than the third and so on. This is why people do not spend the entirety of their incomes on the one type of good they like most.

Of course, people can refrain from buying a house altogether. The most obvious alternative is renting. By renting a person saves money. Another advantage to renting is the increased flexibility. While there are transaction costs involved in switching rental spaces, they are limited compared to the ones associated with selling a house and purchasing another one. However, owning a house means that monthly payments are going towards the purchase of an asset. Houses also provide benefits such as a yard and the psychological benefit of being a home owner. According to economic theory, these alternatives will be compared at the margins. Both options cost money, so the difference in costs between purchasing a home and renting will be weighed against the difference in benefits between the two. Another way marginal thinking works in this case is that people will use it to compare various housing choices. Comparing two houses, one might be more expensive but also have additional rooms. A home buyer considering each of the two will try to decide if he will enjoy the additional rooms enough to justify the extra cost, or if that money will benefit his life more if he spent it in some other way.

Of course, no significant decision is made in a vacuum. The decision to purchase a house is strongly influenced by the current situation in the economy and the impact that has on interest rates, future expectations, and home prices. The current economy is struggling as the Bureau of Labor Statistics (2011) reported that the United States currently faces a 9.1 unemployment rate. This is slightly better than the peak high of 10.1 in October 2009, but much higher than rates in the years preceding this recession, which typically remained between four and six percent. This uncertainty is not conducive to home buying. As said earlier, a mortgage is typically taken out for a multi decade time period and if the borrower is not confident that they will not experience a long term drop in income it is likely in their best interest to avoid such a commitment. By seeing so many unemployed, one can conclude that businesses finding it advantageous to cut workers Also the large pool of unemployed will be competitors for limited numbers or jobs. This makes many unsure of their long term outlook and hesitant to buy a house.

Another impact is that of interest rates. The interest rate is the cost to borrow money and since houses generally require a loan, interest is almost always paid. In this area, the weakened economy may be beneficial since the recession has been met with expansionary monetary policy, which lowers interest rates in an attempt to make borrowing easier. There are many interest rates depending on the type of loan, but in the case of home buying the important rates are fifteen and thirty year fixed mortgage rates. MortgageX.com’s historical mortgage rate date reported (2011) that the current average thirty year FRM is 4.09, while the current fifteen year FRM is 3.29. These are among the lowest of the past few years and significantly lower than the corresponding rates of five years ago, which were 6.40 and 6.06 respectively. Therefore someone with the certainty required to buy a house might find this an ideal time due to low borrowing costs.

Finally, an important factor in the decision to buy a house is obviously housing prices themselves. A weakened economy generally features low aggregate demand, which lowers or slows the increase in prices across the economy. Investment tools data (“Median and average,” 2011) showed this to be the case in house prices as well. The mean home price in the United States in July was $272,300, down significantly from a high of almost $325,000 in early 2007. This shows that it may be a good time to purchase a house, both because it is less expensive and because it may be an opportunity to buy an investment asset at a lower than normal price.

One factor rapidly changing the United States economy is globalization and trade with other countries including those that can manufacture goods more cheaply than the United States. Noted economist N. Gregory Mankiw stated the two main influences this may have thusly, “Even if more competition is good for consumers, it can produce very understandable anxiety among some workers and their families.” (Mankiw,2004) Mankiw ultimately supported free trade seeming to conclude these gains to consumers were larger for society than the losses to some workers. It is easy to see the link to a potential home buying decision. If this trade really does lower consumer prices and increase growth, it makes home buying more sensible as it increases consumers income and lowers what they must spend outside of housing. However, someone in an industry feeling the effects of foreign competition might see their future due to trade as more uncertain and shy away from entering into the kind of debt a new house usually requires.

Despite the low mortgage rates and home prices, I would personally decide not to buy a house at this time. As a student I have low income and while shelter is a priority, renting is a better option that allows me more money to spend in other areas that benefit me more than the marginal benefits between buying a house and renting. Without children an apartment can comfortably fit my needs, lowering those marginal benefits. Also, even if my income could meet that of a minimum home buyer, I would be over exposed to the market and a downturn that lowered my income would have catastrophic results for me. In the future, if I have a family and a larger and more secure income it would make more sense to stay out of this type of purchase currently.

Works Cited

Department of Labor, Bureau of Labor Statistics. (2011). Labor Force Statistics Retrieved from   http://data.bls.gov/timeseries/LNS14000000

Historical mortgage rate data. (2011, September 30). Retrieved from http://mortgage-x.com/x/ratesweekly.asp

Mankiw, N. G. (2004, March 25). Outsourcing redux. Retrieved from http://gregmankiw.blogspot.com/2006/05/outsourcing-redux.html

Median and average sale prices. (2011, July). Retrieved from        http://investmenttools.com/median_and_average_sales_prices_of_houses_sold_in_the_us.htm