Business Cycles And How It Affects The Purchase Of Your Home
So you have reached a point in your life where you're tired of living in a rented place and have saved enough money to buy yourself a home. Maybe, you're in a bit of a different situation. You've been living at the same home for some time and have grown a little bored of it. Maybe, the housing space you require now is significantly larger than the space you needed when you purchased the home. Regardless of your intentions, you have now decided that this is a good time to buy a home.
The decision to buy a home is a simple one but it opens up a Pandora's box of various issues. The location of your home will be a major issue as will the size of your home. However, the biggest issue will revolve around the fiscal components of home purchasing. Buying a home is generally one of the best investments a person can make as property values consistently grow, as this industry represents one of the few true human needs. However, considering the volatile state of the economy, it is important for prospective homebuyers to understand business cycles and how it affects your purchase of a home.
Changes In Economy
Business cycles refer to changes in the economy and are actually not an accurate term. The word cycles infers that these economic changes can be predicted and that there is some type of regularity in its timing. Rather business cycles occur at irregular intervals and for varying periods of time, so consequently a better term that economists use in describing business cycles is economic fluctuations.
These economic fluctuations or business cycles refer to changes in the economy and how these affect various economic indicators. For example, during a period of expansion or boom, the economic trends of overall output and employment show signs of rising. At the same time, unemployment rates fall while new construction and prices rise. However, during periods of an economic downturn or recession, the trends of overall output and employment show signs of decline. Additionally, unemployment rises while new construction fall.
There is not one single way to explain the phenomenon of business cycles and in the political-economy world there are many debates about why business cycles exist as they do. Many economic theorists believe that the principal cause of business cycles are uneven government economic policies while others argue the opposite, that government economic policies are responsible for evening out business cycles caused by the inherent nature of the free market economy. Regardless of the theoretical reasons, business cycles are responses to a number of economic developments, both good and bad.
For the prospective homebuyer, identifying business cycles and how it affects your goal of buying a home is more important than understanding the theoretical causes of business cycles. Business cycles can affect the financial prices of a home due to such varied issues as: its effect on mortgage rates and its effect on the housing market. Additionally, how these business cycles will affect the financial responsibilities of buying a home will differ on your intentions in purchasing a home. For example, if you are buying a home for its investment value as opposed to buying a home as a place to live, you will have a completely different set of fiscal concerns on the issue of homeownership that will be affected by business cycles in a different manner.
Home Sale Prices
The most obvious way that business cycles affects your purchase of a home is how economic conditions will affect local home sale prices. For example, during periods of economic expansion, there is a general trend of increases in overall output, employment, new construction, and prices. Due to the confidence that individuals have in the local economy, economic expansion is the period where there are generally more prospective homebuyers than there are individuals selling their home.
Due to the influx of financial capital, many people feel that a period of economic expansion is the best time to buy a home. Depending on the local economic conditions of where you live, this effect of economic expansion on realty sale prices will be enlarged or minimized. For example, during the dot com boom of the 1990s, real estate prices in the Silicon Valley grew exponentially due to the incredible demand for computer entrepreneurs to find property in an area with a finite amount of available homes. Conversely, in industrial towns such as Flint, Michigan, the conditions of economic expansion would not have as large as an effect on the local real estate conditions evident in other cities.
Therefore, the biggest effect that business cycles will have on your purchase of a home will be on the supply and demand conditions of your local real estate market. This is evident in the way that business cycles when it is in a down period of recession effects real estate sale prices.
During a period of economic downturn or recession, there is a general trend of rising unemployment rates and decreasing overall output. Additionally, the rates of new construction are reduced and prices may continue to rise, they do so at a much slower rate than during a period of economic expansion. Although this may seem like a poor time to purchase a home, it actually may be in your best financial interest to buy a home during a recession.
This is because an economic recession often changes the local real estate market conditions. Considering, the fiscal conservatism that people employ during periods of economic recession, these economic conditions produces few demands in the housing market. Additionally, the increasing levels of unemployment levels caused by a recession means that many homeowners are now put into a position where they are forced to sell their home to accommodate changing job demands. Consequently, an economic recession also produces a large number of homes that are on sale.
With a supply and demand relationship that favors homebuyers, an economic recession produces conditions in which it is possible for prospective homebuyers to purchase a home for a lower asking price than during a period of economic expansion. However, it is important for prospective homebuyers to understand that this principal will vary depending on the city and even in different parts of one city. For example, during the dot com bust the amount of homes that were available in the Silicon Valley skyrocketed and the asking prices for homes in this area dropped dramatically. However, home sale prices in Manhattan will remain relatively stable during economic recessions due to the high demand of individuals that want to purchase a home in this celebrated area.
Mortgage Rates
In addition to the different ways that business cycles can positively and negatively affect the asking prices of homes, business cycles will also affect mortgage rates. Mortgage rates are the most important fiscal component to buying a home and it refers to the monthly payments that you will have to make to your loan source, which had financed a good portion of your home purchase. Mortgage rates that are beneficial to you, the prospective homebuyer, will be ones where your payments will be used to pay down the principal amount that you owe on the selling price compared to the interest accumulated on that principal amount that you owe your loan source.
The fluctuations of mortgage rates are directly tied with the fluctuations of other interest rates. Governed by the laws of supply and demand, interest rates will increase in periods of economic expansion, as there is an increased demand for credit. However, in periods of economic recession there is a reduced demand for credit and therefore interest rates decrease. This formula is further complicated by the presence of numerous interest rates that include:
Prime Rate Treasury Bill Rate Treasury Notes Treasury Bonds Federal Funds Rate Federal Discount Rate Libor 6-month CD Rate 11th District Cost of Funds Fannie Mae Backed Security Rates Ginnie Mae-Backed Security Rates
How interest rates react to changing business cycles are based on the decisions made by the Federal Reserve. Usually, interest rates will rise in instances where signs of inflation become evident. Inflation generally occurs when the economy is growing at a rapid pace. Therefore, to avoid escalating prices, short-term interest rates will increase through an increase in the rate of interest on federal funds. Mortgage rates are affected by this increase of interest rates, as federal funds rate is the interest rate that a bank can charge another bank for use of its excess money. Additionally, the Federal Reserve can change the discount rate, which is the rate paid by a bank to borrow short-term funds from the Federal Reserve. As the discount rate and the federal funds rate are the interest rates that mortgage rates are based on, economic cycles therefore have a large influence on the financial details of purchasing a home.
With high mortgage rates, there will be many prospective homebuyers who will delay the purchase of their home until mortgage rates have decreased to a level that is conducive to their financial situation. However, high mortgage rates have the benefit of limiting the amount of prospective homebuyers whose desire to buy a home supercede their ability to realize that they are financially unable to purchase a home. Therefore, there is a much lower rate of bankruptcies and foreclosures among new homebuyers in times of high mortgage rates.
In times of economic recession, interest rates may reduce interest rates. This is because the rationale behind reducing interest rates is to spur entrepreneurial activity. In a response to sluggish economic conditions, lower interest rates gives incentive to people and businesses to borrow money or refinance existing loans at lower rates. With lower interest rates, there are lower mortgage rates, which usually spurs prospective homebuyers into action by giving them a window to finance their dreams of buying a home.
However, mortgage rate levels do not have the most effect on the financial aspects of buying a home. The type of mortgage rate plan (such as whether it is a fixed mortgage plan or a variable mortgage plan) will have a bigger effect on how much a home would cost. Additionally, how the mortgage plan is structured is an important component of the fiscal duties tied to buying a home. Issues such as whether your mortgage plan is frontloaded, as to pay off the majority of the principal payment (the amount of money that you owe your loan source directly for its contributions to the home's sale price) before paying off the interest on the principal that you owe your loan source, or if it is back-loaded will need to be analyzed.
Your Intentions
Other issues include your intentions for buying a home. For example, if you are looking to buy a home for the sole purpose of taking advantage of its investment value, the housing market conditions that you want will be different from a person hoping to buy a home to live in for a long period of time. For those individuals who want to purchase a home for its investment value, they will prefer a short-term, fixed mortgage rate that may have a higher mortgage rate attached to it.
In this current period, low interest rates have spurred the rise in home buying and selling. With mortgage rates that are conducive among prospective homebuyers' financial situations, the real estate market has never been in a better situation. Although there are always fears of how business cycles will affect the purchase of a home, it is important to understand that owning a home will always be a great investment. By understanding business cycles and how it affects your purchase of a home, you will be able to enjoy the financial benefits of owning a home.
