I was going to write a post on this, but John beat me to it when he made a great comment in the comment section of yesterday’s post. We’ll get to that in a minute, but here’s the quote that got me thinking about the irrationality involved in rushing to buy a home in an attempt to beat the new mortgage rules:
“The mortgage changes come at the worst possible time for Guy Pearson. The Surrey resident, who lives with his wife and three children in his mother-in-law’s house, has been looking to buy a house with a suite and was pre-approved for a purchase price of $340,000. The reduction in the maximum amortization period means Pearson now only qualifies for a $325,000 purchase.
“It’s not a ton, but it’s enough for me to go, ‘Oh my goodness, I’m not going to really get what I want now,’”
The article indicates that Mr. Pearson is wisely considering waiting things out rather than rushing to buy in an attempt to beat the new changes, as some will no doubt do.
Allow me to turn it over to John for an excellent discussion of the rationality involved in such a decision:
“Further to Ben’s topic today, there has been a lot of discussion everywhere about a possible surge in sales over the next two months as buyers attempt to lock in a 5/35. But what price should buyers be willing to pay?
The general consensus forming from economists and bloggers alike, is that house prices will drop by anywhere from 2% to about 8% this year as a result of this mortgage tightening.
However, I read that many people believe the drop in prices will happen after March 18, not before. Indeed many people believe the “surge in demand” will drive prices up over the next two months and many listings will come online to take advantage of the higher prices. In other words, once again demand will be brought forward.
If prices rise over the next two months, it will demonstrate just how irrational markets can be. We have perfect information as of two days ago, that demand for housing is going to be reduced. That, after all, was the point of the announcement.
When a demand reducing announcement is made, the demand curve shifts immediately. The market has perfect information about the future. Any purchaser who is contemplating a 5/35 at price P, will in two months only be able to afford a 5/30 at price P’ where P’ < P.
Thus the class of housing that was in the sweet spot for 5/35 purchasers at price P will immediately shift to the lower price P’. It would be irrational to pay the higher price just because cash flow would allow it. Consider the possibility that prices go down 7%. That 5% down payment is gone and the house is under water.
The rational thing to do is offer P’ now, even if a 5/35 can be locked in. The windfall is taken by the buyer as “economic rents.” Otherwise, wait until the price is forced by the drop in demand down to P’. The cash flow at 5/30 may be very similar to the cash flow that would have occurred at 5/35 simply because of the lower price.
Exactly where P’ ends up will have to be determined in the fullness of time. However, it is clear that, all things being equal, P’ is less than today’s prices. Paying a premium to lock in a 5/35 mortgage today is irrational.”
I am continually impressed by the insightful discussion in the comment section of this blog. Thank you to all commenters for your valuable insights.