difficult economic timers, buying a house is a risky decision. Purchasing a home, particularly for the first time, has always been so, but uncertain financial periods -- the downturn followed by a possible upturn -- make it all the harder. Few prospective buyers are aware of the excruciating decisions that devolve around the purchase, nor are they aware of the economic minutiae involved. Investing background economic principles may make this somewhat easier and this is what this essay intends to do.
According to Nicolas Gregory Mankiw (2006), an American macroeconomist, ten fiscal decisions underlie economy as the base for decision-making. Following these principles can increase profitability, whilst reducing the risk of fiscal loss. The six pertinent principles include the following:
People face trade offs. 2. The cost of something is what you give up to get it, 3. Rational people think at the margin, 4. People respond to incentives. 5. Markets Are Usually a Good Way to Organize Economic Activity (the economy usually does well without government interference) and, 6. Governments Can Sometimes Improve Market Outcomes (sometimes it is necessary for the government to help the economy)
1. People face trade offs.
The principle of trade-off is the consideration that every economic decision features the necessity of sacrificing something in order to gain something else. Buying a home involves evaluating whether the decision to sacrifice is worth it, namely whether buying the home is more important to the person than the sacrifice involved.
Elements of trade-off involve location (sometimes people my be constrained to buy a home in some other location than their preferred one due to the reduction in cost); privacy (those who choose to live in urban areas renounce privacy for doing so); the type of residence that one buys (houses, apartments, or townhouses each affect lifestyle, home's resale value, and monthly finances); and price (renunciations will depend on how much one can afford) (Fontinelle, 2010)
2. The cost of something is what you give up to get it (i.e. opportunity cost)
Opportunity costs will have to be sacrificed in order to purchase this home. The buyer might, for instance, have to frequent Salvation Army for a good long time to come instead of frequenting Macys. he/she might, also, have to cut down on food costs and, in short, scale down her budget to tight limits. The person will always have to choose, and choosing will, inevitably, entail denial of one or more items for the sake of something else. The person who elects to buy the house and, by doing so drastically cuts down on entertainment, food, and clothes, has the opportunity cost of the home vs. The other items that may be strongly enticing to the individual. Here, he or she is cutting down on implicit costs (i.e. items that she may be attracted to) for the sake of covering the mortgage of the home.
It is crucial that the individual take into account all opportunity costs before implementing his decision to buy since assessing opportunity costs is fundamental to assessing the true cost of his or her intended action. Ignoring the opportunity costs may drive the prospective homeowner into steep debt. Thorough assessment of all costs and discipline to follow through is required as part of the decision to acquire the home.
3. Rational people think at the margin
Microeconomics assumes that people act rationally and weigh off price vs. cost often trying to gain optimal benefit from their decision. People often find it more rational to consider marginal rather than the average costs of their decision.
Decisions rarely occur at the seams -- and here Manktow (2006) gives the example of choosing to eat voraciously, or fasting. Rather when one is dieting, one is more apt to tread a mean line adopting 'marginal changes', namely small incremental changes (or sacrifices) in order to obtain one's objective. To that end, rational people often compare marginal benefits to marginal costs.
As relevant to the home, marginal costs refer to the price of the rent paid over a long period of time (a recurring charge) for renting a home or apartment vis-a-vis the one-time cost of buying the home. The marginal costs will be the small, but incremental changes, that the prospective homeowner will decide to make to his or her life in order to afford that cost. Marginal changes in entertainment, clothes, traveling expenses and other daily costs will have to be implemented in order to achieve that house, but the owner may consider it well worthwhile.
The economy's strength can play a key role in determining the aspect of marginal costs. Marginal benefits such as trading, exporting and importing, unemployment, house market and inflation will stay static regardless of the price of the home. The economic mood of the period is the determining factor regarding marginal costs and recessions generally spell buyer's opportunity since marginal costs are significantly lower due to businesses and people forced to decrease prices and sell inventory that aren't selling.
Many more vacant homes are available since potential buyers were compelled to relinquish their dreams due to losing their jobs.
Other marginal costs include the fact that the slow market has also compelled banks to lower their interest rates in order to entice qualified people to buy.
4. People respond to incentives.
This is particulary congruent during economic downturns when a cheaper house or a house drastically reduced will be more appealing than something on the higher end of the market. Put in economic terms, rational people compare costs and benefits and a change in either one may change decisions.
Sometimes, people may find buying the home to be an emergency, or they may so wish to buy the home, in which case they may consider appealing for a loan or getting a cash advance in order to do so.
Other incentives included in buying the home include the purchase itself, tax breaks, and financial security as well as having property that one can sell if one wishes to.
Nowadays, there are even more incentives in stock, since the huge inventory of unsold home is crippling the market so industry players are launching their own temporary incentive programs. Real estate brokerage Coldwell Banker, for instance, launched a "Buyer Bonus" program through which buyers will be refunded 3% of a home's final purchase price, up to $8,000, at closing, whilst Sterling Properties (in the New York State tri-area) is offering a price reduction on most of their select inventory, including a $9,000 refund on apartments in its new development (Gonzalez Ribeiro, 2010). One of the best way to assess the highest incentives, according to Ribiero (2010) is to approach realtors particularly the National Association of Realtors' website at Realtor.org, and the National Association of Home Builders.
5. Markets Are Usually a Good Way to Organize Economic Activity
The aspect of Markets also configures into the equation of buying a home. Certain fiscal periods may be more advantageous to acquiring a home than in others, and recessions are certainly one. During this period, individuals are forced to relinquish their dreams of buying certain property. Other individuals are compelled to foreclose and foreclosure offers the best deals. Mortgage rates may be at a dramatic low creating a combination of events that creates an ideal buyer's market for those considering buying a home for the first time.
6. Governments Can Sometimes Improve Market Outcomes
The government also plays a great part in the decision of buying a home. The Worker, Homeownership and Business Assistance Act of 2009, for instance, granted first-time homeowners a tax credit of up to $8,000 for buying their principal residence. This is a huge incentive!
Expansionary fiscal policies promulgated by the government may well encourage home buying during recessions. Expansionary fiscal policies are characterized by the federal government attempting to solve recession by expanding money supply via decreasing taxes, introducing rebates and involving itself in increased government spending. Reduced taxes increases consumer spending, opening consumers up to more readily acquiring homes.
Our current economic default has pulled down interest rates further making the market more appealing to prospective homeowners.
Finally, in order to buy a new home and in order to receive the best mortgage rates, most would-be-home buyers would need solid credit ratings, a decent down payment, and documented income verification. Job security is essential, as well as carefully considering that one is buying a home (that one wishes to live in for at least three to five years) not impulsively buying an investment that one will later regret. A buyer's monthly housing payment shouldn't exceed 35% of their gross monthly household income, and, as regards taking advantage of low interest rates, Kenneth Rosen (chairman of the Fisher Center for Real Estate and Urban Economics at the University of California-Berkeley) suggests that buyers should target a 30-year, fixed-rate mortgage. Finally, buyers are recommended to negotiate and to cautiously check out foreclosures since these may be their best market yet (Mullins, 2009).