By: Dr. Mike Campbell
For most people, the largest purchase that they are ever likely to make in their lives will be a home purchase. In almost all countries where free-market forces are allowed to predominate, house prices have risen at a faster rate than wages since World War II. However, political and social pressures have come to bear which mean that more people than ever before aspire to own their own homes.
The only way for the average person to be able to buy a home when house price inflation outstrips wage inflation is to enable them to borrow more money against their earnings and/or to increase the repayment period on the loan. Schemes now exist where borrowers only pay the interest component of their loan (i.e. the capital is never repaid and so the “buyer” never owns the property) and of course the whole sub-prime fiasco was about making loans to people ill-placed to afford them.
Demand drives prices and there is a wide-spread belief that “bricks and mortar” is the safest investment that there is – however this is not quite true. Demand is a double-edged sword, so when the global recession struck, the number of people willing to buy existing homes or to have a new home constructed fell. Link this to a tightening of borrowing conditions and demand shrivels and dies meaning that if you wish to sell your home, you need to drop the price. House prices around the world have fallen as a result of the global recession.
In the USA, 11 million homeowners have now earned the appellation “underwater borrowers”, meaning that the current value of the property they own is less than the value of the loan on them – in the UK, this situation is referred to as “negative equity”.
The housing sector is central to the US economy; as it is in most countries. A refinancing scheme will be extended to US home owners with “underwater loans” which should allow them to renegotiate their loans. For many of these people, the loans were secured at a typical interest rate of 5% with a lifetime of 30 years; currently, these mortgages cost 4%. If householders can renegotiate their loans, they stand to reduce their monthly repayments by 20%. The hope is that this money will then be released into the economy through the purchase of other goods and services.