Final Project: A New House-Decision
Anna Schultz
XECO/212
October 30, 2011
Chiara Yates

Final Project: A New House-Decision
Many of our decisions are influenced by the state of our economy. Purchase of big ticket items such as appliances, furniture, autos, and a home follow a line of investigation before the decision to purchase is implemented. The purchase of a home is one of the largest investments made in a lifetime, and uses many factoring influences before purchase. This paper will show how economics plays into the decision of the purchase.
One of the first areas to consider is what the trade-off will be in purchasing a home versus the benefit of renting. What we need to consider is if purchasing a home and providing more space, and living closer to shopping and schools, justifies the added cost in utilities and maintenance of a home.
The opportunity costs are another factor to consider. We can vacation closer to home instead of the trip to Europe we had hoped to take. Another option would be to maintain our existing auto instead of buying a new car.
We need to research the marginal costs we would need to pay out. These include the amount of down payment, closing costs, taxes, insurance fees, and moving expenses. If we rent a larger apartment, we won’t have those costs, but we also wouldn’t have the benefit of ownership/write-off of interests in loan and property taxes. Monthly rent costs may be as much for a larger apartment versus a home that could be smaller than a rental, but we would own the real estate. Rational people (Mankiw, 2007) weigh the benefits of home ownership knowing the initial costs are expensive, but over time the benefits out-weigh the added costs. The marginal benefit are considerable in the long run after the house has been paid off. The value of the house will increase after all the years of payments and will outweigh the marginal cost.
Next we need to find which type of loan we qualify for and will fit our budget. Research states that monthly housing costs should be below 29 percent of our gross monthly income. Insurance and property taxes need to be figured into that amount. Being a veteran, it may be beneficial to check into the advantages of a veterans’ loan. If we pay 20% versus 10% down payment, the interest rate will be less. After researching the types of home loans, these are our options:
Traditional Fixed Mortgage- This type of loan has a locked in interest rate throughout the length of the loan. Our monthly payment will be the same each month regardless of the state of the economy. The terms are for 15 or 30 years, with the 15 year loan providing a lower rate of interest.
Government guaranteed loan such as FHA, Ginnie Mae, Freddie Mac, and HUD loans- These loans are most often used by the first time buyer that have a moderate or low income. The Federal Housing Finance Agency (2011) The loans are easier to qualify for than a traditional fixed mortgage, the down payment requirement is usually around three percent, and the loans are guaranteed by the Federal Housing Administration. Another advantage is that the interest rates are lower than a fixed mortgage rate.
Flexible payment ARMs- This type of loan has a monthly adjustable interest rate with no cap on the rate. The borrower initially has a low payment every month, but the payment increases over the term of the loan, often sharply. Balloon Loan- This loan is like a fixed rate, but is usually for five to seven years. When the loan term ends, the balance needs to be paid in full, or the outstanding balance can be refinanced.
Interest Only Mortgage- This loan requires payment of only the interest for a set period of time. The monthly payment is applied only to the interest, and provides the owner a lower payment each month for a short term of time. When the interest only timeframe expires, the required amount of money includes the repayment of principle, have higher rates and a shorter repayment period. The longer the interest only period, the higher the payments will rise after it expires.
Biweekly and Bimonthly Loans- A biweekly loan is when the borrower makes a payment every two weeks instead of once a month. This applies more money toward the principle, and shortens the length of the loan. Paying biweekly in effect gives 26 payments a year equaling 13 monthly payments. The bimonthly loan saves on interest by making a payment every two weeks on average, by paying one half of the monthly payment every two weeks, saving a bit on interest by advancing the payment. This type of loan will shorten a 30 year loan by approximately one month.
VA Loan- This is a government backed form of loan in which the borrower must have or have had honorary military service, or be a surviving spouse of a veteran. The applicant is given the loan with little or no down payment.
Any of the above loans are subject to national fiscal policies by the government. These bodies of government are the Department of Treasury and the Federal Reserve. The Feds will determine lending/interest rates, and the Department of Treasury provides funding for programs in low to moderate income loans. The lending rate defines/establishes if lenders are able to borrow money from the Federal Reserve. When the rates are low, more money is available to lend, and the reverse is also a factor. When rates are low, demand for housing increases. When the rates rise, less money goes into the economy and housing demand falls. Housing prices are elastic, and are determined by supply and demand. According to Mankiw, 2007, the definition of demand is “the percentage change in the quantity demanded if the price changes,” and elasticity of supply is “the percentage change in the quantity supplied if the price changes.” If interest rates increase, demand will be lower or even stagnate. When rates are low, home prices may increase along with demand.
Another area to consider is the strength of our economy. When the economy is strong, the marginal costs should produce close to equal marginal benefits. Consumers will buy homes as long as the marginal benefit is beyond the price paid. Since we have excellent credit, and employment with stable incomes, we should prove to be good candidates for a home loan.
According to the Phillips Curve, years with low unemployment tend to have high inflation, and years with high unemployment tend to have low inflation. (Mankiw, 2007). To stimulate growth in a weak economy, the Fed will supply more money into the economy to stabilize aggregate demand so interest rates will go lower. The economy today has low interest rates and fiscal deficit tend to be high. Because the quantity of money demanded is higher with a weak economy, interest rates tend to increase and consumer spending goes down, and factoring in lower GDP figures, normally it would not be a good time to purchase a home. Interest rates along with home values are simply low because of economic conditions, short sales and foreclosures. In a strong economy, the dollar value is worth more, fiscal and monetary spending is low, GDP up, along with consumer spending. There is an increased demand for goods and services, making markets more competitive. (Mankiw, 2007). Purchase of a home would give the best return on the dollars spent. The consumer price index will give an idea of the cost of living expenses, but research of the GDP is a better indicator of how the economy is doing. If the economy is good and prices are normal, housing values will hold steady and possibly grow because demand will be higher. When considering a home, determine if the value of what you’re interested in is equal to or better than other homes on that street. If the neighborhood is sub-par, the value can decrease and make it more difficult to sell in the future.
If mortgage interest were not deductible, housing values would fall, but interest rates may also stay lower to entice people to purchase a home. The older generation would suffer the worst because of the fall in housing value. (Assuming they have purchased their home many years prior, at a higher cost/rate). The young would benefit because housing prices would be lower and more obtainable, and the housing prices would not fluctuate as they have in the past.
When the government is spending money, implementing monetary policies will affect tax rates, increasing them to pay the deficit created. Higher taxation will cut into disposable income, and the dollar value may decrease, causing inflationary conditions. If there are rebate programs or reforms in the mortgage market, it may give reason to delay the purchase. The economic conditions of a recession or slowing will make the GDP fall and create a negative effect on consumers. Home buyers will have less purchase power due to lower dollar value in the country’s currency, the job market instability, and less disposable income will make it difficult to afford a home and related expenses. The marginal costs will also outweigh marginal benefits when purchasing a home because of the need to spend increased amounts on necessities of food, gasoline, and clothing as an example.
The domestic and international trade will affect the housing market and economy. If the government spending is up, trade in exports down and consumption by the population down, the dollar will be weak. Inflation will be higher along with interest rates and available funds for purchasing any goods. The reverse is also true to create a strong economy.

• Real GDP is growing, but is weak when it is compared with postwar normal recovery.
• Because the economy shrank by 5.1 percent during the recession, today's output remains 0.5 percent below its previous peak in 4th quarter 2007.

• In every prior recovery, the accumulation of household debt has grown as the recovery starts.
• In the current recovery, the collapse in home prices damaged household balance sheets. As a result, consumers have avoided taking on new debt.
• The effect is weak consumer demand and a slower recovery.

With consideration being given to all factors, now is not the time to consider purchasing a home. If the potential purchaser has job stability, along with an adequate amount of down payment, with the housing market and interest rates being at an all-time low, consideration can be given in purchasing a home. I say this because there are good deals to be had with foreclosed and short sale availability of homes, but other factors need consideration.
The economy is in a recessionary period, consumer spending is down, government debt is high, and the population is experiencing high unemployment along with more disposable income being used to maintain lifestyles. The international economy is experiencing the same issues as the United States economy, so I feel the time is not right to purchase a home.

References
Book:
Mankiw, N.G. (2007). Principles of economics (4th ed.). Mason, OH: South-Western Cengage Learning.
Web
Swartz, P. (2011). Quarterly Update: The Economic Recovery in Historical Context. Retrieved from http://www.cfr.org/geoeconomics/quarterly-update-economic-recovery-historical-context/p25774?cid=ppc-Google-CGS-chart_book-recovery-economic_recovery&gclid=CMH-2Mu9hq0CFaQbQgodwj659Q
Ginnie Mae - Government National Mortgage Association - GNMA Read more: http://www.investopedia.com/terms/g/ginniemae.asp#ixzz1jIYndpZB. (2011). Retrieved from http://www.investopedia.com/terms/f/fhaloan.asp#axzz1jIY6P1i3
Cecchetti, S. G. (1996). Mortgage Interest Deductibility and Housing Prices. Retrieved from http://people.brandeis.edu/~cecchett/frbc96c.htm
LendersMark.org Staff Writer. (2006-2010). Mortgage options - An overview. Retrieved from http://www.lendersmark.org/types-of-mortgages.htm
Barnes, R. (2011). Economic Indicators: Overview. Investopedia ULC. Retrieved from http://www.investopedia.com/university/releases/#axzz1jMK7TPHR
Federal Housing Finance Agency. (2011). Retrieved from http://www.fhfa.gov/