Buy or Not to Buy The Financial Essay

  • Length: 7 pages
  • Sources: 4
  • Subject: Economics
  • Type: Essay
  • Paper: #90891172

Excerpt from Essay :

Buy or Not to Buy: The Financial Advisability of Purchasing a Home in the Current Economy

The recent and ongoing events in the national and global economy have caused a major reevaluation of priorities and possibilities for large corporations, government entities, and individual consumers in terms of their financial security and futures. Many firms and investments that seemed to be unshakeable foundations and unstoppable earners are simply and suddenly gone, and a vast amount of the world's wealth has disappeared along with them. The value of many commodities has also dropped significantly as consumer spending has slowed, and the general pull-back of the economy has led to rising unemployment rates in much of the world that are only now beginning to show signs of settling back down after more than two years of climbing. In short, the economy has been doing things that no one really expected, and this has caused a great deal of continuing uncertainty.

Few areas of the economy in the United States (as well as in certain other countries) experienced more volatility than the housing market. The real estate boom (or "bubble") has been cited by many analysts as a major source of the economic downturn as a whole, with inflated home prices being driven by shady mortgage lending practices and vice versa. When homebuyers began defaulting on mortgages they could never really afford, banks began failing and home prices began to plummet as it became clear that few consumers could afford to buy them, and few lending institutions had the funds to help them.

This is, of course, a highly oversimplified explanation of what occurred in the housing market, but it is enough to give one pause in considering their own purchase of a home. Though home ownership has long been seen as a -- if not the -- major step towards financial independence and security, the reality of this view is definitely questionable in the current climate. In the following pages, a variety of considerations that are directly relevant to the decision of whether or not to purchase a home will be examined in order to determine the financial advisability of moving ahead with a purchase in the current climate. Ultimately, of course, this decision is dependent on an individual's specific financial situation and also must include certain non-financial considerations, but by looking at the various costs and benefits of home ownership a more rational and realistic assessment and decision can be made, even in this time of ongoing volatility and uncertainty.

Economic Principles

There are several basic economic principles that are art of the consideration that must be made in regards to the purchase of a home. The simple rules of supply and demand have a direct effect on the affordability and the advisability of a home purchase, affecting not only the actual price of real estate but also influencing the availability and cost of the capital necessary to make such a purchase (Fish 2011). Other issues such as opportunity cost, compound interest, and amortization must also be taken into account, so the some concepts might be simple on the surface their interactions are in actuality quite complex.

Supply and demand has a direct impact on home prices; when there is a high demand for homes to purchase -- i.e. A lot of buyers -- with lower supply levels, prices go up. Fortunately, the reverse is also true, and in many areas of the country prices have dropped considerably because fewer people can afford to purchase a home in this economy -- there is lower demand. For those that are in stable and ample enough financial situations, this means buying a house right now would be a fairly good idea, all else being equal, as lower home prices means a greater value and potential return (FinPipe N.D.). Interest rates are also affected by supply and demand, through one of the most basic financial concepts there is: the time-value of money (Fish 2011). Simply put, the concept of the time-value of money asserts that the value of a dollar today is not the same as the value of a dollar at some other point in time (Fish 2011). This relates to many other financial concepts that are highly relevant when considering whether or not to purchase a home.

Most home buyers cannot afford to pay cash for their homes, but instead must borrow most of the value of the home from a lending institution. Essentially, the purchaser is using future dollars that they will earn before they have earned them -- they see a greater value in being able to use those dollars now -- and they pay the bank interest for this privilege. Meanwhile, the banks funds come from individuals that see more value in having their dollars later, and they let the bank lend these dollars to other individuals for the privilege of earning interest on those dollars (Fish 2011). A lot of savers with few borrowers means there is low demand for now-dollars, and thus interest rates drop -- borrowing is an easier privilege to come by, so it costs less (Fish 2011). This is the situation that exists now.

The low home prices and very low interest rates that exist make this a very attractive time to purchase a home compared to other periods. This does not mean that the decision should be made on these features alone, however. The time-value of money must also be considered form another angle: opportunity cost. Money that is spent on a home mortgage is money that cannot be spent elsewhere, so the cost of owning a home must be compared to the alternatives in order to determine if its makes true financial sense (FinPipe N.D.; Secor 2010). In other words, just because buying a house is cheaper right now than it has been for quite some time and than it is likely to be for another long period, not everyone should necessarily be clamoring to purchase a home. It is often cheaper to rent the type of home one wants to live in than it is to buy a home, and this must be taken into account (Secor 2010).

The issue of opportunity cost is impossible to adequately address without a specific situation and concrete figures at hand. Money spent on a mortgage is building up some sort of value, though the home's value might not build up quickly enough to recoup money lost to interest during the life of the loan (FinPipe N.D.; MI 2009). Furthermore, the down payment needed to purchase a home could be invested in a number of different financial growth tools -- CDs, bonds, stocks, etc. -- and could be earning interest at a faster rate than the purchased home appreciates (FinPipe N.D.). This would make purchasing a home a less reasonable financial decision, depending on the earning potential of investments compared to home appreciation.

To complicate matters further, the interest that is paid on a loan is generally tax deductible, while interest earned from investments can be taxed; this adds some amount of additional savings to home ownership and additional costs to using that money as a means of investing and growing wealth instead (MI 2009; FinPipe N.D.). The decision of whether or not to purchase a home, then, must be based on a rational and comprehensive calculation of all of these factors, with specific interest rates on the home loan, projected earnings on investments, comparable rental prices, expected increases in home value (almost impossible to predict in the current market), and the length of time one expects to own the home all taken into account. Using the last of one's saving to purchase a home with mortgage payments that will not allow them to build up savings quickly is probably a bad idea, while a purchase that still allows for long-term cash investments and savings is more attractive, assuming equal home values and expected appreciation levels (Secor 2010).

Macroeconomic Effects

The term "opportunity cost" is often used in a highly qualitative way -- buying a house means not being able to invest; renting means not being able to build equity in real property, and this is an opportunity cost. A related concept is marginal cost, which essentially reflects the same thing but in a quantifiable form. This can be compared to the marginal benefit, which is a numeric representation of what something is worth to the consumer. A high marginal benefit would generally be associated with a low marginal cost, and vice versa.

In the current economy, the marginal benefit of owning a home is highly questionable, from a strictly financial viewpoint. There is no guarantee that home prices will rise considerably in the near future, and even the long-term prospects of home increases might not beat inflation (FinPipe N.D.). The same can be said of alternative areas of investment, however; though the stock market has seen a major rebound in the past year, continued gains are by no means assured, and in fact stocks were…

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