Head: HOUSES IN A FREE MARKET

The Factors That Determine the Price of Houses in a Free Market



The Factors That Determine the Price of Houses in a Free Market

 

Introduction

Some Economists and housing analysts argue house prices are significantly overvalued and are due to fall in the near future. Some paint a doomsday scenario of falling house prices leading to recession. Should we be concerned about a decline in the housing market?

Factors That affect House Prices in UK

Economic Growth / Real income.

Rising incomes enable people to spend more on buying a house. Traditionally, there was a mortgage ratio of 3 times your salary. Basically if you earnt £20,000 the building society would lead £60,000. Therefore rising incomes enable house prices to rise.

However, the ratio of house prices to income can vary considerably. For example, between 1995 and 2007, the ratio of house prices to incomes have increased significantly. see: House Price to Incomes ratios

If the economy goes into a recession and unemployment rises, the demand for buying houses would fall significantly.

Interest rates

Interest rates affect the cost of paying for a mortgage. Interest rates are very important as mortgage repayments are usually the biggest part of a homeowner's monthly spending.

In the UK, the majority of homeowners have a variable mortgage which means an increase in rates will cause the cost of mortgages to rise, detering people to buy.

People on fixed rate mortgages will be insulated from fluctuating rates for 2-10 years. Therefore changes in interest rates can have a time lag of upto 18months before there full effect is noted on demand for housing.

It is also important to consider real interest rates (interest rates-inflation)

The Bank of England set base rates and these usually affect all commercial rates. However, sometimes the Bank of England cut interest rates, but, commercial banks don't pass these cuts onto consumers. In the first half of 2008, the Bank of England cut rates by 0.5% from 5.5 to 5.0%, but the cost of mortgages is still rising.

Consumer confidence

During times of high consumer confidence, people are more willing to take out risky mortgages to be able to buy a house. For example, in the period 2001-07 100% mortgages and interest only mortgages were quite common. In the early 00s, people were optimistic about the housing market and so took out mortgages with a higher debt to income ratio.

Availability of Mortgage Finance

In the 50s, 60s and 70s, there were stringent restrictions about the availability of finance. However, with deregulation of the banking sector increased competition has seen a rise in the number of mortgage products. Products such as interest only, self certification mortgages and mortgages up to 6 times income have enabled people to get more mortgages, thereby increasing demand for housing. However, during the credit crunch of 2008, the number of mortgage products on offer fell due to a shortage of finance in the money markets.

Demographic factors

There has been a rising number of households in the UK. The number of households can rise faster than the population if ...