How the Availability of Credit Affects Home Mortgage Prices

Last Modified: 10/13/07
First Published: 09/29/07
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The availability of credit is historically tied to the price of homes and other assets simply because of supply and demand. The more credit there is available, the more demand will exist for assets of all types.

Just as a greater availability of credit will increase the price of homes, the reduction of credit will just as quickly reduce the prices of homes.

The situation currently has the supply of homes increasing, both resale and new construction, so that alone would lead to deflation in home prices. Although that is not the only pressure pushing home prices down. If credit availability is reduced, those homes must come down much further to become affordable to those individuals who do not have access to large amounts of credit.

You would expect demand to increase as home prices continue to fall and inventories build, but if those homes are still too expensive relative to the lack of credit available, they must fall further.

Another pressure that will pull down prices further is that those sellers who are looking to sell their home will not easily sell at a loss. As they wait for prices to pickup, especially in hard-hit areas, they are not buying the homes they really want. The multiple downward pressures on home prices may not fall off for many years.

The chart above indicates that for at least the last 40 years prices have been increasing relative to median household incomes. The biggest pressure on home prices may be the increasing availability of credit, including government-back mortgages.

Note how 2006 spikes when compared to the other decades. If alone that number corrects to the 40 year historic value of around 2-3 times median household income, then prices have a ways to fall.

When looked at on a regional basis, certain areas may actually continue to have price increases, as those areas may have an entrenched historical price stability because of certain permanent industries, such as the government. It does not seem all areas will suffer a dramatic decline in home prices.

If you assume an increase in government involvement in the mortgage industry then perhaps prices may not fall as they should. The FHA (Federal Housing Administration) and other government agencies have already taken steps to effectively increase the availability of credit.

Note: data source

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