The Economics of Homebuying

This lesson provides an overview of the basics of buying a home for the first time. Your students may make this decision sooner than they think. Although buying a home is the largest financial decision most people make, two-thirds of American adults do buy a home. In this lesson, students examine programs that make first-time home-buying more affordable. Then they examine over time several economic factors that influence the number of homes purchased. Finally, students use a mortgage calculator to find out how the size of the down payment, length of the loan, and interest rate affect the cost of the loan.

This lesson provides an overview of the basics of buying a home for the first time. Your students may make this decision sooner than they think. Although buying a home is the largest financial decision most people make, two-thirds of American adults do buy a home. In this lesson, students examine programs that make first-time home-buying more affordable. Then they examine over time several economic factors that influence the number of homes purchased. Finally, students use a mortgage calculator to find out how the size of the down payment, length of the loan, and interest rate affect the cost of the loan.

In order to read the first article and the historical home affordability data, students need the https://acrobat.adobe.com/us/en/acrobat.html.

• Analyze the costs and benefits of home ownership.
• Describe the factors that affect affordability of home ownership.
• Use cost-benefit analysis and knowledge of home-buying procedures to reduce the costs of home ownership.
• Analyze the factors that affect the cost of a mortgage.
• Read and interpret charts and graphs.

• Adobe Acrobat: This is where students/teachers will be able to download the Adobe Acrobat Reader for this lesson.
  https://acrobat.adobe.com/us/en/acrobat.html
   
• On the Brink: This article on the costs of first-time home buyers appeared in The Wall Street Journal Classroom Edition in February 1999.
  www.econedlink.org/lessons/docs_lessons/121_nn121_coverstory1.pdf
   
• Economic Factors that Influence Home Sales Charts: These charts include data for the following six economic factors that influence home sales: Median Household Income, Median New-Home Prices, Interest Rates, Affordability Index, New-Home Sales, Demographics.
  www.econedlink.org/lessons/docs_lessons/121_nn121_charts1.pdf
   
• Mortgage Rate Analyze Rate Activity: This is the link to download and/or print the chart that compares the four mortgages in the lesson. Students can fill in the chart by using the mortgage calculator.
  www.econedlink.org/lessons/docs_lessons/121_nn121_mortgage1.pdf
   
• Mortgage Calculator: This website is where students will find the Mortgage Calculator for the Mortgage Rate Analyze Rate Activity for this lesson. Students will need to plug in the initial principle (mortgage amount), annual interest rate, and term (in years) for each of the four mortgages.
  https://www.mortgagecalculator.org/
   
• Your Housing IQ: Allows Students to test their Housing IQ.
  Housing IQ

Home ownership. is part of the American dream. But for some people, the cost of home ownership. seems more like an American nightmare. Buying a home usually is the largest financial commitment that a person or family ever makes. Buying a home for the first time can be particularly intimidating.

Buying a home, however, is easier and more affordable than you may think. The keys are understanding the procedures and processes of home ownership. and developing the skills to reduce the costs of home ownership.

In this activity, you'll see that there are many programs that help consumers buy a first home. Although some of these programs reduce initial costs, they can raise long-term costs. Next you'll analyze the economic factors that influence the costs of home ownership. Finally, you will use a mortgage calculator to master the basics of comparing the costs of mortgages. This is important because the cost of the mortgage is the largest cost of home ownership. Understanding the components of mortgage costs and comparing those costs among several lenders can save you thousands of dollars. Let's get started.

Read On the Brink. This article on the costs of first-time home buyers appeared in The Wall Street Journal Classroom Edition in February 1999.

After reading the article, answer the following questions.

View Interactive Activity

1. What percentage of adults now own a home? [66.8 percent]
2. What percentage of new mortgage loans in 1998 were given to borrowers with down payments of less than ten percent? [33 percent or 1/3]
3. Besides lower down payments, what programs have helped more people buy homes? [Federally-funded grants for down payments, government-subsidized interest rates, and special loans for people with poorer credit ratings]
4. How would a recession affect lower-income home-buyers helped by these government programs? [Income might be lower, and defaults on mortgages and foreclosures might increase.]
5. Should the government help low-income people by encouraging and subsidizing lenders to reduce down payments and interest rates? Why or why not? [Students could answer this question individually or it could be a question for class discussion. On the positive side, these programs increase home ownership., and new homeowners feel more a part of their community. On the negative side, new homeowners might be unable to make the payments or maintain their homes during a business downturn. This could increase financial problems and the emotional stress related to these problems.]

Now let's examine the economic factors that influence home sales. You will examine the data in six charts. The scale for the data on these charts is on the left vertical axis. The horizontal axis tracks these data over the past 29 years. The light blue shaded areas represent economic recessions in the United States. The economic factors that you will examine are:

1. Median Household Income. This is the middle level of income. To obtain this number, line up all household incomes in declining order and move down to 50 percent.
2. Median New-Home Prices. Use the same techniques as for determining median household income. This is the middle level of the price of new homes.
3. Interest Rates. This chart shows the average interest rate on existing homes for each year.
4. Affordability Index. This chart relates median income to home costs. For example, if incomes rise and interest rates fall, homes become more affordable.
5. New-Home Sales. This chart shows the number of new homes sold each year and the number of homes still for sale at the end of the year.
6. Demographics. On this chart, the red line shows the number of people aged 25 to 34, the age when many people start buying homes. The blue line shows the number of people aged 60-69, the age when many people start selling their homes and moving to smaller apartments or condominiums.

Before analyzing the data in the charts, please read the longer descriptions, which accompany the charts. Now click on Charts.

First let's answer some factual questions.

View Interactive Activity

1. Look at the home ownership chart. How has the percentage of people who own their homes changed since 1970? [The rate has risen slightly in the 1990s but stayed around 65 percent for the past 30 years.]
2. What was the dollar increase in median household income from 1975 to 1997? What was the percentage increase? [To calculate the percentage increase, subtract the 1975 median from the 1997 median and divide by the 1975 number. Convert this answer to a percentage. Median income has increased 214 percent. $37,005 – $11,800 / $11,800 = 214%]
3. Find the percentage increase for new-home prices from 1975 to 1997. How does this percentage increase compare with the percentage increase in median income? [Median new-home prices have increased 271 percent. $146,000 – $39,300 / $39,300 = 271%. Median new-home prices have increased more than median income. Of course, new homes have many features older homes did not.]
4. Compare interest rates in 1982 with interest rates in 1997. Which year's rate is higher? [1982]
5. New-home prices hit a record high of $146,000 in 1997. Despite this, why was it easier for many people to buy a new home? [Median household income was up or mortgage rates were down.]
6. Explain what the "affordability index" is. What does an index number of 100 represent? [This index shows the ratio of median income to the income needed to qualify to buy a median-priced single-family home. An index of 100 or higher is an indicator of favorable conditions for prospective buyers.]

Now let's analyze the data and see what conclusions we can draw.

View Interactive Activity

1. How does median income affect home sales? Home prices? [A higher median income increases home sales. As people make more money, they can afford higher home prices.]
2. Explain the relationship between interest rates and:
   1. The affordability index. [As interest rates rise, houses are less affordable. The index numbers are lower. As interest rates fall, houses are more affordable. The index numbers are higher.]
   2. The prices of new homes. [Interest rates affect the amount people pay for a mortgage, which has an impact on the price people pay for homes.]
   3. New homes sold. [Higher interest rates contribute to a decline in home sales.]
3. Why do interest rates have this effect on home sales? [Higher interest rates increase the total cost of a home because interest on the mortgage is a large part of housing costs.]
4. How do recessions affect home sales? Why? [Because incomes are usually lower and more people are unemployed in recessions, fewer homes are bought and sold.]
5. Why did both the number of new homes sold and the prices of new homes sold rise in 1996 and 1997? [Houses were more affordable because interest rates were low and incomes were rising. These economic factors caused an increase in the demand for housing.]
6. Compare the number of 25-34-year-olds with the number of 60-69-year-olds in 1989. How will this ratio change in the 2020s? How do you think these changing ratios will affect the housing market? [There were more than twice as many 25-34-year-olds as 60-69-year-olds in 1989. In the 2020s, the number of 60-69-year-olds rises sharply as baby boomers enter their 60s. This may decrease the demand for homes or at least change the type of home people want to buy.]

Now it's time to shop for a mortgage. There are three keys to reducing mortgage costs. First, the larger the down payment, the lower the principal of the loan. If you borrow less, you will pay less interest, which is the cost of the loan. Second, the lower the annual interest rate, the less interest you will pay. The annual interest rate is the percentage of the loan (principal) that you pay in interest each year. Your total payment minus the principal equals the total dollar amount of interest you will pay for the loan. Finally, the faster you pay off the loan, the less interest you will pay.

Let's analyze four different mortgages with different down payments, annual interest rates, and time periods. All of the home buyers are buying a $125,000 house.

1. Kyle and Amber Campbell pay 20 percent down and take out a $100,000 mortgage. It is a 30-year fixed-rate mortgage with an annual interest rate of seven percent.
2. James and Linda Snyder qualify for a special down payment of only five percent. They take out a $118,850 mortgage. It is a 30-year fixed-rate mortgage with an annual interest rate of seven percent.
3. Benny and Silvia Ramirez qualify for a special program that lowers their fixed annual interest rate to six percent. They make a 20 percent down payment and borrow $100,000 for 30 years.
4. Jill Baldwin knows that paying off a mortgage more quickly will save her money. She makes a down payment of 20 percent and borrows $100,000 at a fixed rate of 6.5 percent. Because she will pay off the mortgage in 15 years, her annual interest rate is lower than she would have paid for a 30-year mortgage.

These four mortgages are compared in the chart below. Notice that the monthly payment and total payment (principal plus interest) are blank.

You will fill these in, using the mortgage calculator.

Use the following link to download and/or print a worksheet for the activity above. Mortgage rate analyze rate activity

Using a mortgage calculator is easy. Just plug in the initial principle (mortgage amount),
annual interest rate, and term (in years) for each of the four mortgages. Check monthly payment amounts and total payments. Now go to the https://www.mortgagecalculator.org/ and fill in the rest of the chart.

Based on your chart, answer these questions.

View Interactive Activity

1. What happens to the monthly payment and total payment for a loan with a smaller down payment? [Both the monthly payment and total payment are higher.]
2. What happens to the monthly payment and total payment for a loan with a lower annual interest rate? [Both the monthly payment and total payment are less.]
3. What happens to the monthly payment and total payment if the term of the mortgage is 15 years rather than 30 years? [The monthly payment is higher, and the total payment is much lower.]
4. What is the trade-off if you get a 15-year mortgage rather than a 30-year mortgage? [You pay more each month, which is tough on the budget. However, you save a lot in interest.]
5. How can you reduce your cost of buying a home? [This is a good question for closure. Make a larger down payment, shop for the lowest interest rate, and pay off the loan as quickly as possible.]

Your Housing IQ:

Test your housing IQ using the following interactive activity.

View Interactive Activity

Check your Home-buyer IQ Score: