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Chapter 4: Q.6 (page 133)

If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?

Short Answer

Expert verified

Despite rising mortgage rates, the true cost of financing a home is thus lower.

Step by step solution

01

Step 1. Introduction

An interest rate indicates how much it costs to borrow money or how much it pays to save money. So, if you're a borrower, the interest rate is the cost of borrowing money expressed as a percentage of the entire loan amount.

02

Step 2. Explanation

Compute real rate of interest:

r=i-π(Before)r=5%-2%=3%(After)r=10%-9%=1%

People are more likely to purchase homes now that the real interest rate they must pay has dropped from 3% to 1%. People are repaying more in dollars, but their property prices have increased at such a rate that the true cost of financing their homes has decreased.

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