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Effects of falling prices in the housing market

A fall in house prices is usually given prominence in the front pages of the press. This is because the housing market and house prices are often seen as the barometer to the state of the economy. If house prices fall, people tend to believe the economy is falling as well. Here, we examine the real effects of falling prices in the housing market.

Negative effect of falling house prices

Generally, a fall in house prices reduces equity withdrawal, which leads to reduced consumer spending and consequently low economic growth. This negative multiplier effect can cause a full blown recession. In the recessions of 1991-92 and 2007-2008, for example, falling house prices were factors that led recession although other factors such as government spending and investment also contributed to the economic meltdown.

Positive effect of falling house prices

In addition to falling housing market reducing the wealth of home owners, equity withdrawal and consumer spending, the fall also reduces inflationary pressure in the economy. When inflation pressure in the economy falls, creditors and mortgage lenders often reduce the interest rates on loans. This is usually good news for people with high mortgage repayments because it means their loan repayment interests also fall.

Moreover, when mortgage interest rates fall buying a house suddenly becomes attractive and within the reach of more people. This is because house price to earnings ratio improves when house prices fall and there is an extended period of flat house prices. First time buyers who previously would have struggled to buy a house are able to take mortgages and meet their mortgage repayments easily.

Bottom line

A fall in house prices and housing market makes buying more realistic and is actually beneficial for homeowners who have no need to sell their house or remortgage. However, a drastic fall in the housing market can be detrimental to the national economy. Ultimately, therefore, the impact of falling house prices depends on the severity of the fall. A fall of between one and two percent is not too serious, but a fall of 10% would probably cause more harm than good.

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