House prices can only go up if there is more money available – so what determines how much money is available?

How much money is available is determined by a number of factors: the two key factors are interest rates and wages.

Interest rates:

Interest rates need to be low. Why do you need this? The lower the interest rate, the more people can afford to borrow from the bank in terms of a mortgage. Put simply. If the house you want to buy is £500,000 and the most you can afford in repayments each month is £2,371 then (for a 25 yr mortgage) the highest interest rates can be is 3%.

If interest rates dropped to 2% then you could get a mortgage for £560,000 all other things being equal. Note how you now have £560,000 at your disposal. If everyone had that, guess what the selling price would be for a house? You got it. £560,000. This is all thanks to a drop in interest rates.

Wage growth

Wages need to be going up.For that to happen, you need a growing economy. How are the two linked?

Take this example:

If you have 10 people in a village and all 10 work for the only business in the village for an annual salary of £20,000 per year then how much can they borrow assuming banks will lend 4 x salary? £80,000 right? Right. Now, new scenario. There is a big demand for the product the business is making, so much so that another business from out of town sets up shop just outside the village. This new business needs workers so it approaches 2 of the workers at the existing business and asks them to come and work at the new business. The workers say that they are happy at the old business and don’t want to move. To incentivise the workers to move to the new business, it offers them £25,000 per year. The 2 workers accept this offer. Now how much can each borrow from the bank? At 4 x salary, it would be £100,000. This, in turn, affects how much a property will sell for if there is competition among buyers who have higher incomes (and consequently can access larger mortgages).

So you can see how an increase in competition for labour that comes about in a growing economy can cause house prices to go up. Put simply – a growing economy is good for house prices.

An additional observation. For prices to go up, you also need a positive outlook by the public

While this does not affect how much money is available, it does affect prices.

This is how:

When people are positive about the future of house prices (i.e. they think interest rates will drop in the future and they think that the economy will improve), they are sometimes willing to buy now before those factors are priced in. If enough people think this way then demand goes up (even though interest rates are still high and the economy is not doing well). There is of course, a limit to this. If, after a few years, interest rates don’t drop and or the economy does not improve then people’s outlook will eventually change from positive, to stable and eventually to negative. If that happens they are less likely to want to buy property and consequently, demand drops. This drop in demand adjusts prices down.

 

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