House Prices Essay, Research Paper

Economics Coursework: The Price MechanismIntroductionI have been asked to investigate a question similar to ?What determines the price of a particular good or product?. I have chosen to answer the question,What determines the price of houses?I have also come up with a hypothesis related to my question, later in my investigation I will either prove or disprove this theory. My hypothesis is,House prices are mainly determined by mortgage rates.To collect my information I will use a wide range of resources. These will be:?The Internet, particularly specialised sites dealing in economics (e.g. www.bized.ac.uk, www.moneyextra.co.uk) ?I will try to arrange an interview with someone working within a bank or an estate agent. I will hope to gain a lot of information from these two sources?I will create and use a questionnaire and ask about 20/30 people, with a mortgage the questions on the questionnaire. This is because if I asked someone of my age what they thought, the set of results I would be getting back from my questionnaire would not be as accurate as they could be if I asked someone who owned a mortgage. ?I will try to use as much of my class work as possible. I will need to look at my notes on Demand and Supply. Main AnalysisI will start by looking at the main determinants for the supply and demand.A table to show the main determinants for the supply and demandDeterminants of demandDeterminants of supplyPrice of the good / servicePrice of the good / serviceIncomeCosts of producing the good / servicePrice of substitutes / complementsObjectives of the firmTastesProfitability of alternative productsExpectations of future price changesShocksWith the buying and selling of houses there may also be additional factors that affect people’s supplying or demanding decisions. The main determinants of the demand and supply of houses include:A table to show the main determinants of demand and supply for housesDeterminants of demand for housesDeterminants of supply of housesPricePriceIncome / level of economic activityThe price of landThe level of rentsThe cost of building materialsInterest rates (mortgage rates)Expectations of future price increasesThe ratio of income to house pricesThere are also other factors to take into account that effect the demand for a property, these are ?It?s size?It?s age?It?s locationBuying a house takes far more money than most people usually have available, and so they often have to borrow a loan from a bank, building society or other financial institution for the purchase of a house. The loan is usually secured against the property; meaning that if the borrower fails to meet the loan payments the lender can repossess the property to recover their money. There are four main types of mortgage rate:Variable Mortgages: Most mortgages are taken out at variable rates of interest. This means your lender sets an interest rate and from time to time this will be moved up and down in relation to general movements in interest rates in the wider economy. Variable rate mortgages are the ‘plain vanilla’ variety in the home lending market. Fixed Mortgages: These offer borrowers a guarantee of what their mortgage payments will be for a set period of time. An interest rate that does not vary with rates is generally convenient for budgeting. You, of course run the risk that mortgage rates generally will fall below the level at which your mortgage rate is fixed. But equally, you’ll be insulated from any significant upward swing in mortgage rates. These deals have been popular in the U.K. in the early 1990’s after consumers experienced very high home loan rates in the preceding three years. Fixed rate deals often involve the borrower agreeing to a penalty charge – often up to six months interest – if they decide to redeem or repay the mortgage early. In the UK most fixed mortgage rates are fixed for a period of 1 – 10 years, unlike in the USA where it is normal for the rate to be fixed for the entire mortgage term.Discount Variable Mortgages: In the competitive environment among home lenders, there are a variety of offers that promise a discount off the prevailing variable interest rate. In other words, the interest rate on offer is set at a set margin below the standard variable rate. This ‘discount’ may be for a number of years, but in some cases lenders have offered big discounts for short periods of time. E.g. 6% off your home loan rate for six months. These offers are, in a sense ‘too good to be true’. They invariably involve the borrower agreeing to stay with the lender for a period of time or face ‘withdrawal penalties’. Capped Mortgages: This is a variable rate mortgage with a capped limit. An interest rate is charged in line with current prevailing rates, but the borrower is given a guarantee that the rate will not exceed a certain amount. These offers are usually for a limited period. The advantage to the borrower is their mortgage rate can fall but there is a limit to how high it can rise in the event that mortgage rates increase generally.Interest Rates: One of the key determinants of demand for houses is the interest rate because most people finance the buy of a house by borrowing money. A high interest rate means high loan repayments and will therefore restrain the demand for houses. So the lower the interest rate of a loan for a property, the higher the demand for houses because the loan repayments will be lower. At a time when the rate of interest is low (such as now) the repayments of a mortgage work out to be cheaper than renting, which is a common alternative. The level of ?cheapness? leads to an increase in the demand for houses and that leads to an increase in the price:The leftward shift in demand increases the price from P to P1 this extension in the market means the quantity rises from Q to Q1. If interests are high then the opposite will happen.The shift is to the right and this drops the price to P1 and the market contracts the quantity to drop to Q1Of course the interest rate is not the only determinant of demand for houses. Another important one will be the level of income that people have. The faster the level of income people earn is growing the more money they have to invest in their houses. The overall level of income in the whole economy is known as GDP (Gross Domestic Product) and so if we looked at the behaviour of that we could see how the level of income on average has grown. Affordability (Income): Another thing that effects demand for a property is the affordability of the mortgage this means, how easy is it to pay the monthly mortgage? In 2001 properties are more affordable now than before. In 1990 – approx 2/3 of household income would go on servicing the mortgage. Today, that figure is just above 1/3. So – just think if: ?- 50 year mortgages become available ?- Britain joins euro (lower interest rates) ?- Market for mortgages continues to be competitive ?- Interest rates continue a long term decline ?- Incomes continue to increase faster than inflation …Then property will be more and more affordable and so values will go up So a 50% increase in 5 years is very possible – in areas of great demand (like Richmond, Surrey) it?s more likely to top 75%! Values should continue to increase.Booms and busts:As the level of income over the past 2 years grew, so did the demand for houses. Property prices in England and Wales continued to surge in the second quarter of last year with the average cost of a home rising more than 8 per cent. Figures released by the Land Registry show homeowners in Greater London enjoyed a spectacular rise of 12.3 per cent in the value of their properties compared with the same period last year; the average cost of a terraced house in England and Wales is now ?69,148. Last year it was ?63,950. In the past 40 years, there have been two major booms in the UK’s owner-occupied housing market: in the early 1970s and in the late 1980s (the Lawson Boom). There were also smaller booms in the 1960s and, more briefly, in the late 1970s, while the early 1990s saw a bust on an extraordinary scale, at least for the UK. It is now recognized that the increases in housing wealth which took place in the 1980s contributed significantly to the consumer boom of the 1980s. Many factors conspired to produce the house price boom of the late 1980s. Initial debt levels were low as were real house prices, giving possibility for rises in both. Income growth after the early 1980s recession was strong, as were income growth expectations and these became more important as a result of financial liberalization, though partly offset by bigger real interest rate effects. Wealth to income ratios grew and the spend ability of assets was enhanced by financial liberalization. Financial liberalization also allowed higher gearing levels. Graphic trends were favourable with stronger population growth in the key house buying age group. The supply of houses grew more slowly, with the construction of housing falling to a small fraction of its level in the 1970s. Finally, in 1987-8 interest rates fell and the proposed ending of property taxes in favour of the Poll Tax gave a further drive to evaluation. The bust in the early 1990s was the result of the reversal of most of these factors. Interest rates rose from 1988-90. Income growth and growth expectations weakened. Demographic trends reversed. The revolt against the Poll Tax resulted in a new property tax, the Council Tax, being reintroduced. Debt levels and real house prices had reached very high levels, while wealth to income ratios then fell and recently experienced rates of return became negative and made households more cautious. Mortgage lenders tightened up their lending criteria, in a partial reversal of financial liberalization. Under these conditions, not even the major falls in nominal interest rates that took place in the early 1990s, while real interest rates remained high, were sufficient to revive UK house prices. Evidence for such unpredictability can be found in the years 1989 to 1995 when house price to income ratios have gone from the second highest peak in the post-war period to the lowest level, probably since before the War. These events can be shown more clearly in the table below,YearEconomics GrowthBoom / Recovery / Recession / Slowdown??Effect on demand for houses??Increase / Decrease / Stay same??1987-1989HighBoom(”Lawson Boom”)Increase1990-1992LowRecessionDecrease1992-1995 ModerateRecoveryIncrease – but only very slightly due to high level of negative equity1995-HighBoom (?)Increase – reduced negative equity leading to recovery in the housing marketHouse prices now, however, are starting to level off Figures from the UK’s biggest mortgage lender, Halifax, and the biggest building society, Nationwide, show house prices coming off the boil. However, the figures contrast in terms of how sharply the property boom is declining. The Halifax says house prices went up 0.5% in August but that the annual rate at which they are rising fell for the fourth month in a row to 7.4%. It says this shows that the market has steadied after four price falls in the past five months. But the Nationwide recorded a 0.6% price drop in August – the biggest monthly fall for two years – and an annual rate of 11.2%. The Halifax puts the average house price in August at ?84,811 while the Nationwide figure is ?80,737. At the same time as the figures were released, property developers Taylor Woodrow predicted that house prices would continue to rise despite the current slow-down. It said that although house prices were softening in some areas, notably London and the southeast, the market remained strong in other parts of the country. However, the economic adviser to Deloitte & Touche, Roger Bootle, has pointed to tax changes that he says have ?acted against the speculative property purchases that tend to fuel housing booms?. The abolition of mortgage interest tax relief and big increases in stamp duty on sales over ?250,000 have made buying and selling properties much more expensive. This, he suggests, will moderate demand, resulting in much greater stability in house prices over the coming years. Graphs to show the above information:1983 – 1989Substantial increases in demand; particularly 1987 onwards. Budget reforms in 1988, deregulation of the financial industry and rapid economic growth (”Lawson Boom”) all led to substantial increases in house prices, though with regional differences (”North-South divide”).1989 – 1992Higher inflation led to increases in interest rates forcing many repossessions from over-borrowing. Recession and increases in unemployment also led to rapidly decreasing demand. High levels of “negative equity” by the early 1990’s. 1992 ? nowSlow and gradual recovery in housing market. Level of negative equity reducing and lower interest rates help to give small increases in demand. Economic growth gradually increasing.ConclusionThrough looking at my information above and all of my notes I would be accurate in saying that my hypothesis was wrong. As with all things, demand drives up prices. So, the fewer properties on the market coupled with a growing demand for homes will increase demand and buyers start to outbid each other. Also, every one wants to live in the best districts of our towns and cities – so these will always be in demand, without the demand for a product the product would not be built, as long as there are people living there will always be a demand for accommodation of some sort.Economical Glossary Demand: Demand is the quantity of a good or service that a consumer is willing and able to buy at a given price in a given time period. (See effective demand). For normal goods there is an inverse relationship between quantity demanded and the good’s own price.GDP (Gross Domestic Product): GDP measures the value of output produced within the domestic boundaries of the UK. It includes the output of foreign owned firms that are located in the UK.Money: Money is any asset that is acceptable in the payment of transactions or in the settlement of debtsMaximum Price: Governments can impose legally binding maximum prices to set a statutory price ceiling in a market. To be effective a maximum price must be set below the free market price. The normal effect is to create an excess demand for the good or service. This requires some mechanism for rationing the available supply.Supply: Supply is defined as the willingness and ability of producers to supply output on to a market at a given price in a given period of time. There is usually a positive relationship between supply and price. See also price elasticity of supply and conditions of supply.