A healthy economy is certainly a good thing when it comes to demand for housing, but how much can the economy actually impact the real estate market?
Both the economy and housing market influence each other to some degree. More specifically, here are a few ways that the economy impacts the real estate market and what that means for buyers and sellers.
Spending Confidence Weakens
When things are more expensive to buy, consumers are less likely to spend their hard-earned money. Generally speaking, consumers are more likely to spend their money on expensive goods – including real estate – when they’re more confident about the economy.
If the economy is on unstable ground, however, consumers will be more likely to be wary of what they spend their money on. In this case, they’ll be more apt to holding onto their capital until they’re certain that whatever they’re spending their money on is worth the investment.
In terms of the housing market, buyers are more comfortable spending their money on a home if the economy is looking up. This reinforces consumer confidence in spending and is healthy for the real estate market. In this case, demand is usually higher, driving up prices of homes on the market. But an unstable economy will usually result in fewer people buying homes, which decreases demand and sends home prices plummeting.
In a weak economy, consumers don’t want to risk losing money, so they’ll be less likely to spend hundreds of thousands of dollars on a home that may end up decreasing in value.
Housing Starts and Home Sales Slump
Both housing starts and existing home sales are important indicators of a strong economy. If the economy is weak, the supply of money tightens and lending criteria tends to become more stringent, making it even harder for buyers to make a purchase.
Funds become more difficult to borrow, and fewer buyers get into the real estate market. Further, housing inventory usually escalates and takes much longer to sell.
Mortgage Rates Increase
One of the more obvious things that buyers will notice when it comes to the economy and housing market are the interest rates on mortgages. Interest rates are crucial factors when it comes to housing affordability.
In addition to the actual price of homes, the mortgage rates themselves can determine whether or not a buyer will be able to afford to make a purchase or not. Even a fraction of a percent can mean the difference of thousands of dollars over the life of the loan.
These days, buyers are looking at spending an average of $565,330, which is what the median home price is in California right now. At a mortgage interest rate of 4.69%, borrowers who put a 5% down payment would end up with monthly mortgage payments of $2,768. That’s a pretty heavy amount for many homebuyer hopefuls with average salaries.
And with each incremental increase in the interest rate, the mortgage payments will subsequently increase. When the stock markets take a turn for the worse and the surrounding economy suffers, interest rates tend to go up. That’s because lenders need to hedge against the risk of loaning out money to borrowers during times of economic uncertainty.
The ripple effect is felt in the real estate market. With higher interest rates come more expensive mortgages, which makes buying a home out of reach for more consumers.
When the stock market and economy are stable, however, the opposite is true. Mortgage interest rates can plateau and even decrease when things have normalized in the stock market.
Required Down Payment Amounts Increase
Not only do higher mortgage interest rates make a home purchase less achievable, so do higher down payment amounts. Much like when lenders charge higher interest rates to hedge against the potential risk of loaning money in an unstable economy, they’ll also require buyers to come up with a higher down payment amount for the same protection.
The more money a consumer is able to put down on a home purchase, the less money the lender needs to loan out. A small loan amount is less of a risk for lenders than a higher one. But coming up with a hefty down payment amount can be pretty tough.
A high-ratio conventional mortgage requires a 5% minimum down payment, which would translate into a down payment amount of $28,266. That’s quite a bit of money for consumers to have to come up with. And if the economy and stock markets aren’t performing up to par, many consumers might not have as many assets to pull from any investment portfolios if they’re depending on such investments for a down payment.
But an economy that’s doing well and a stock market that’s seeing more green than red means that investing consumers’ portfolios may be better able to provide them with the cash needed to put towards a down payment.
The Bottom Line
A good, strong economy is good for everyone, including buyers, sellers, real estate agents, and the housing market as a whole. While a healthy economy might strengthen a housing market, a weak one can have an opposite effect. Of course, that doesn’t mean that buying or selling in a weak economy is a bad idea or even impossible. As long as your finances are in order and you’ve got a seasoned real estate agent behind you, it’s certainly possible to make a sound purchasing or selling decision, even when the economy has room for improvement.