An excerpt from a Globe and Mail article on the upside of debt:



(Emphasis is mine)

That last sentence struck a chord with me. It got me thinking - is it true? If there were no such thing as mortgages, would home ownership become unattainable for the general public? At first blush, it certainly seems true. After all, who has $350,000 sitting around with which to buy a house?

But the more I thought about it, the more I questioned this assumption. It's certainly true that very few people can come up with the huge sums of cash it would take to buy a home outright. But isn't it also true that that very fact would exert enormous downward pressure on home prices? Doesn't that statement completely ignore the "demand" half of "supply and demand?" If there were no such thing as mortgages, would that $350,000 house still cost $350,000? Wouldn't it be significantly cheaper?

If all of a sudden, everyone had to pay cash for houses, the real estate market would shift dramatically. Homes listed for $350,000 would either sit on the market for vastly longer terms than they currently do, or they'd do what sellers have done since the dawn of time when unable to attract buyers. They'd lower their price until it sold.

Maybe the reason houses cost so much is precisely because of mortgages. Numerous economic studies which highlight the enormous burdens facing this generation's middle class cite 2 key factors in our reduced quality of life compared to our parents and grandparents: The dramatically increased cost of education and housing.

It just so happens that the past decade has represented a historical "golden era" of easy access to exactly those two kinds of debt (student loans and mortgages). Coincidence? Or cause and effect?

Is easy access to credit - the very thing that's supposed to be improving our quality of life - distorting the "supply/demand" equation to the point where our lifestyles have become too costly?

If there were no such thing as mortgages, and people had to pay cash for homes, would the "housing" component of our budgets settle back down to a more reasonable piece of our income pie? Would we be able to buy homes for 1/2 to 1/3 of their current prices, freeing up money that could be used to improve our quality of life, or fund our currently-woefully-underfunded retirements? Are the banks and their easy-credit responsible for the squeeze on the middle class?

Of course, nobody has to borrow the money if they don't want debt. But isn't it kind of like an arms race? If you and a stranger both want to buy the same house, but you insist on paying cash and he's willing to take on a 35-year mortgage, don't you have to be willing to take a mortgage, in order to compete? The price of the home will be driven up by virtue of his willingness to shoulder debt, regardless of your own commitment to paying cash. As a result, whatever house you buy will have its price inflated - even though you're paying cash - because your competition is getting an artificial "boost" from cheap credit.

I think you are partly correct. If access to credit were harder then house prices probably would be lower. In a sense this credit crunch is contributing to the slow recovery we are seeing. Credit is an engine that facilitates economic growth.

I think an equally important question concerns what a world without mortgages would be like. I think few people would own homes. They would be at the mercy of fat-cat landlords. Few would build equity in anything. You would produce a polarized economy of haves and have nots. Think of images of the early 1900s - pre-depression even.

Perhaps I am wrong but I think that is what would happen. I don't really see a flaw with your argument, I just think the broader repercussions are what make mortgages important.

I would also add that there are a few studies that have looked at housing prices over many decades, one I am thinking of looked at prices for over 100 years. The finding was that house prices tended to track the cost of raw building materials. Credit availability and interest rates have short term effects. But the mean price seems to be driven by the price of materials. If I'm not mistaken, housing prices declined in the late 19th century even while credit was relatively loose. The decline fits well with the fact that commodity prices (think lumber and nails) fell upwards of 50% between 1870 and 1896.

I think you are partially correct. I think that cheap credit allowed people to buy homes that cost a larger percentage of their income than they otherwise would.

In the last 50 years, average home size has gone up(until very recently), while the average number of children has gone down. Basically, people are buying larger, more luxurious homes and using cheap credit to pay for it.

In part, you can blame the middle class for their own downfall, as people have steadily spent larger percentages of their income on square feet that is unneeded(and probably just filled with Stuff).

Cash-only would drive down prices.

Homeownership would drop. Shrug ... the general public just would not have the fiscal discipline to take advantage of the lower prices.

What if there was no credit/people coudn't get credit?
Maybe people would end up doing what most other cultures did up until recently, which was build their own house. My great grandmother walked the paces, put in the stakes, and using local materials and paying local workers built a very modest house (in Greece) that she raised her family in. Most (developing) countries where credit as we know it doesn't exist, still have houses, just very modest houses that the homeowners either built themselves or paid for as they went (building piece meal). Probably the most comparable thing here are trailer homes, and going to the more fringe, things like cabin kits, straw bale houses, yurts and the like.

Another possible trend will be family members, multiple generations, moving in together, and squatters in foreclosed buildings/homes.

Of course you are right about this. In countries without wide availability of credit people do what they need to to build houses.

But lack of available credit is a major limiter of economic growth in the developing world.

and what would happen to rent prices? in my present location, the average cost of a home is a bit of a sticker shock to me. apparently it is to many others, since renting is a pretty popular alternative.

funny thing, rent is really expensive here. more so than mortgage payment on a local-market house expensive.

Rent prices would continue to be driven by income.

Certainly more people would be renting but we'd have more houses available for rent.

What if there was no credit/people coudn't get credit?
Maybe people would end up doing what most other cultures did up until recently, which was build their own house.

Exactly. I mean this whole crisis mess is due to cheap money and credits. The dollar-bills have just become paper and the gouverment works in this way with credit rates near zero percent. Gold is the way to go.