Economic Strength in a New House Purchase Decision - Research Paper Example

? Business Studies Buying Decision - A New House Due The report highlights the role of economic strength and its contributing factors in a new house purchase decision. A couple requires a bigger space from the current rented apartment they are living in as they are expecting a baby. They are evaluating their decision and assessing other options available by considering basic principles of economics related to purchase or rent a house by comparing marginal benefits with marginal costs associated with the purchase; evaluating the strength of the economy and its affect on the marginal costs to arrive at a wise decision. Key words: House, Economy, Domestic Economy, GDP - Gross Domestic Product, BEA - The Bureau of Economic Analysis, purchasing power, inflation, international trade. John & Tia are living in a rented studio apartment at a location near to their offices and commercial area which is ideal for them. However, they are expecting a baby and require bigger space to have room for baby’s nursery and a location that is near to clinic / hospital, school, nurseries, day care centers and other social service offices they might need to consult after they have the baby along with continuation of their respective careers. Both to-be-parents are confused whether to rent a bigger place or make the ultimate investment of buying their own house in an economy that is gradually improving from recession. This is a major investment for the couple that requires a substantial financial expenditure which is going to alter their financial position, spending habits, saving percentage etc. Consequences of this substantial investment would firstly require savings and other investments evaluation. They have been saving for few years and have sufficient amount to make the down payment and pay mortgage for at least a year. Hence they are prepared financially however, they need to be emotionally willing to take the huge plunge into this big investment as well as cope with resulting restrictions, requirements and tradeoffs involved. They need to assess whether their current income flow is sustainable and can support mortgage payments for the future period. If mother-to-be has to quit job in order to take care of the baby would they be able to afford making payments regularly and how will they manage their financials? They also need to evaluate if it is the right time to take the leap or they should stick to rented option. Their detailed assessment of the economic situation, evaluation based on economic factors and weighing down of options is given below. Majority of the decisions we make as consumers are directly related to or influenced by the prevailing economic conditions. Our future plans are shaped in accordance with our expectation of how the economy will perform. We shall refer to a few of N. Gregory Mankiw’s principles related to the principle of making the purchase decision and influencing factors. According to Mankiw, there is no “free lunch” we must give up something in order to get something i.e. every decision has its costs / tradeoff. In our case tradeoffs are the plans couple had already made earlier that they now need to forego or put on hold, such as yearly vacation and a new car. They would also have fewer saving hence restricted spending priorities since now they also have to consider extra savings for future expenses related to raising a child as well as maintain the new house if the go ahead with the decision. Further tradeoffs would be loss of interest income being earned on the savings and opportunity cost lost on account of not having the same amount invested to gain profit. This factor would evolve into the second principle by Mankiw which involves considering and weighing the costs of decisions, i.e. opportunity cost which is ever present. The couple would be losing on the opportunity to have the amount saved and interest being earned giving them financial strength instead of having it spent on down payment, monthly mortgage payment and insurance payments. Other actions forgone such as vacations and a new car can be achieved later on and not necessarily on the same planned budget but lower as well. Third economic principle of Mankiw is that rational people think at the margin, to gain the most benefit compared to the associated cost of the action. The couple would be gaining a new family member and a huge asset with the purchase of the house along with peace of mind and self actualization feeling of achieving an asset which they can decorate and design as per own preference without any hassle of getting landlord’s approval and intervention. They would be nearer to community and services that are essential for a child’s upbringing like school, hospital, day care etc. This would save their time, energy and also provide ease in picking and dropping the child at school or day care center that is nearer to their house while commuting to and from their offices. However, having work place distance increased from the new house, the couple would opt for public transport that would be a cheaper option than driving on their own to work and would save them the hassle of driving, parking and related costs. On the other hand several unavoidable costs are also present with the purchase of a house such as utilities, repair & maintenance costs, insurance, landscaping, mowing and gardening services cost, paint & upkeep. However the long term benefits coupled with immediate benefits of homeownership are of more substance (Simon & Greenberg, 2011). It allows us to deduct mortgage interest on the taxes (especially beneficial to high tax brackets). Rental monthly payments are almost similar to the amount of monthly mortgage payments; however, in the later case assurance is of living rent-free in the future along with equity to play with after mortgage is paid off and monthly expenses significantly reduced. Fourth principle says people respond to incentives. While comparing costs and benefits people can change their decision if change occurs in any one of them. People generally respond easily to price change incentive. As explained above living in a house would provide numerous cost incentives in the long run than living in a rental place along with ownership of a huge asset. Further, if prices of the houses are kept attractive with low mortgage payments people would readily opt for the option of homeownership. Let us now consider now economic strength influences the decision of purchasing a house. Strong economy generated is a resultant of low unemployment, monetary stability, balanced trade, efficient resource allocation, job stability & sustainable businesses, healthy wage rate, increasing income of people with improving lifestyles. Good wages lead to increased purchasing power hence making more people upgrading themselves with the title of home owners hence marginal benefits would overweigh the costs in a strong economy. Similarly in an opposite situation when the economy is in distress it will affect the consumers adversely. Organizations would opt for downsizing when costs are not being met and hence result in high un-employment and reduced purchasing power. Hence, people will have low disposable income and would live on their savings; hence purchasing a house would be of their least priority, hence making marginal costs outweigh the benefits in this case. Further the low disposable income might also make people’s credit card debt increase which is another factor that many lenders see as a warning sign and refrain from giving house loans to highly indebted consumers. Economic performance affects the cost of homeownership directly by determining the market price at which the house would be purchased (cost) and later on the future market value of the house (benefit), both primary factors that can weigh down or weigh up the decision to buy a house. Further, down payment, interest rates, requirements for qualifying for a home loan by lenders / banks and buyers ability to sustain the expenses of purchasing a home also depends on the economic strength. Domestic economy and international trade play a pivotal role in overall economic strengthening. Domestic production, consumption and distribution of wealth in a balanced manner promote enhanced GDP (gross domestic product). According to the Bureau of Economic Analysis (BEA) the real GDP of USA in 2010 was $ 14.7 trillion, which is the highest production figure in the world. A growing GDP hence indicates a strengthening economy. Rapid changes in the GDP allows investors and consumers to assess their asset allocation and consumption, further, high GDP rates indicate best opportunities for investors. In case of house purchasing decision growing GDP indicates raise in interest rates to curtail inflation. In such a situation adjustable rate mortgage scheme would result in high interest expenditures in the future, hence one can have follow the insight and get into fixed rate mortgage scheme. Declining GDP results in downsizing and high unemployment rates again triggering the low purchasing power trend discussed above. Current economy is reviving after seeing the great depression; however, the result is gradual with many reforms that have changed the market indicators. Currently the home prices are considered as flat due to abundant availability of real estate, hence an attractive opportunity to purchase a house at low cost. Another economic factor international trade is directly linked with the currency’s strength which affects consumer’s purchasing power. Imbalanced trade or trade deficit results when the imports exceed the exports of the country, indicating high consumption and low production, which also increases reliance on other countries as well as the inflation, making things out of reach for the consumers. Hence government makes budget cuts on the spending where ever it is possible to stabilize the economic deficit and provide consumers with buying power and confidence. After discussing influence of some of the monetary policies, let us now consider the impact of fiscal policies on the decision of purchasing a new house. One of the factors that influence the decision to purchase house is revenue collection (taxes). If the government removes or reduces tax deduction on mortgage interest, the demand for houses shall decline since its marginal cost increases. Government increases income tax, leaving people with less disposable income, hence low purchasing power again reducing purchasing power for houses. However, when government increases spending on the infrastructure of the economy, it results in attracting investors and hence economic growth. Ultimately consumes are given a favorable outlook and ability to invest in a house. Considering the need of having a bigger house near to social communities and services, comfortable for the couple as well as the baby to come, keeping in view the financial stability and funds availability, marginal benefits overweighing the marginal costs, improving economy with incentives in investing in a house and positive economic outlook, the couple shall go ahead with the proposal of purchasing a new house as per their requirement and change their spending priorities and economize spending to save more. However, if the economic outlook had been depressed with the possibility of one or both of the partners losing their jobs in the near future, the decision would have been completely different. Since, the leap to purchase the house mainly depended on the affordability of the down payment, mortgage payments and availability of funds. References Fischer, Stanley, Dornbusch, Rudiger & Startz, Richard (2002). Macroeconomics. New York, McGraw-Hill. Mankiw, N. Gregory (2004). Ten Principles of Economics. Retrieved from McCarthy, George, Zandt, Shannon Van & Rohe, William M. (2001). “The Social Benefits and Costs of Homeownership”. Joint Center for Housing Studies, Harvard University. Retrieved from < http://www.jchs.harvard.edu/publications/homeownership/liho01-12.pdf> Simon, Ruth & Greenberg, Jessica Silver (2011). “Why it’s Time to Buy”. The Wall Street Journal. Retrieved from Read More