Help understanding housing prices

**Originally posted in the forums by Jleslie in Nov. 2006**

I’m trying to find answers to something that’s been bothering me lately. I am by no means an economist, and I hope these thoughts don’t seem too silly so here goes:

My questions are about housing prices and how banks effect them. I was born and raised in the Canadian province of Saskatchewan. The price of a normal starter house in Saskatoon when I left was probably around 120,000 USD. The neighboring province of Alberta was probably double or even triple that. It would be even higher in a city like Vancouver, or Toronto. I have recently moved to the UK (London) and prices here are at least double again. I’m afraid I don’t have exact figures, they aren’t really important because I think most people would agree with me so far.

Now, to the best of my knowledge the longest mortgage available in Saskatchewan is 30 years. I believe banks in Alberta and BC offer 50 year mortgages. I’ve heard 70 years in Ontario (could be wrong), and here in the UK apparently you can get a 100 year mortgage.

This makes sense in that longer mortgages would likely be necessary in order for someone to afford to buy in the more expensive market. But, my question is, what comes first? Does the increase in value force the banks to offer these deals, or do the banks CAUSE the increases by offering these deals? I suspect that they are intertwined and it’s impossible too separate the cause and effect nature. However, either way, does this system have an end? Is there a time when the average person can no longer enter the property ladder? Is there a limit to what the banks can offer?

I hope that made sense :), and I thank everyone in advance for hints they can offer.

5 comments

  1. Demand is one side of the equation, but you also have to look at ability to pay. When interest rates are low and credit is easy house prices go up because more people have the ability to pay more (the how much a month crowd). When rates rise and lending gets tighter prices go down.

    In Canada the CMHC has an effect on house prices through their mortgage insurance and mortgage buy-back programs. During the recession they were told to approve as many loans as possible, which made house prices start climbing again after briefly dropping, but is this just demand borrowed from the future?

    By the way, here’s a fun visual for one specific market: Vancouver BC house prices for the last 35 years represented as a roller coaster.

  2. The answer to your question is demand. Thanks and have a nice day.

    Ok seriously. The major banks do not have the power you suggested they may have. Everything revolves around demand. Look at the market today, although the interest rate is relatively low (compared to 1989 :P) hosing markets across the entire country are not booming. Yes, Alberta has incredible prices, but that’s only because there is incredible demand. Vancouver’s housing prices would drop off if people didin’t demand houses that aren’t around. Limited supply and great demand increase prices, not interest rates. It is true, however, that the government (the central bank, not the major banks, the central bank,) could control hosing prices. They would do this by increasing interest rates and make borrowing less attractive. The housing market would slow and prices would drop as some places would have excess supply from either movers or excess buildings.

    Another way the market moves it again, demand, but this time via consumption. The US hasn’t moved interest rates much, their rates are lower than canada, but the housing market is facing a crisis. People aren’t buying homes cause they don’t like the climate, they don’t have confidence to borrow right now for whatever reason…..

    80 year loans are stupid… if you can avoid them do so, why borrow so much and live in debt your entire life? Get a bigher down payment, borrow less, live in a smaller house… Don’t leave your kids with house payments….

  3. Hello and thanks for your reply. While demand must be responsible for housing prices in general I’m sort of after something more subtle. Specifically, in the case of first time home buyers. It seems to me that these ‘stupid’ loans are targeted at them. And, they seem to exist in markets where that first rung of the property ladder is really high. I agree with you completely that one should avoid an 80 year loan if they can, but, I would argue that in these expensive markets, they can’t.

    Which brings me back to the original thought: which causes what. I suppose from a pure demand stand point, the banks must offer these loans in order to meet the demand, but what would happen if the banks didn’t offer them? Or simply, if they never approved people for $400,000 loans, would there be any $400,000 houses?

  4. No the banks don’t offer first. This would put them in a money problem.

    Usually the central bank will lower interest rates which will push the housing market into more activity (depending on consumers confidence). The banks will lend accordingly. REally though, they won’t lend out to someone who won’t pay back regardless of time period of the mortgage. 80 years is a lotta year to default. Loans that are too big should be avoided, just move to the country….

    The banks follow what the central bank does. If the central bank lower interest rates than they will lower, if they raise, they will raise, not the othe rway around.

    If the little banks did this they’d loose lots of money a), through money markets and overnight markets because they’d be lending at a lower rater and buying at a higher rate, b) they’d be lending in an environment where people would be borrowing more and the possibility of defaulting is higher.

    The overnight rater is the big one since there are massive ‘clearing markets’ every night as banks change money between each other…..you just don’t want to loose money off of interest rates if you don’t have to. Especially if you’re a billion dollar bank.

  5. Try considering the mortgage as a privately-offered subsidy (well, potentially private anyways) in a housing supply/demand graph.

    Banks (or, the central bank) uses interest rates to play with consumption (and/or interest rates), including housing.

    In Microeconomics 1, we think of a subsidy as being something that makes markets inefficient, but some markets have externalities that need to be taken into account, so we don’t usually consider central bank interest rate adjustments to be a bad thing (if you’re fortunate enough to be in a country that has a good central bank).

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