Affordability and emotion
We know that buying a house can often be more than a simple financial decision – lifestyle and emotion play a role too.
But prices – and affordability – are important factors, and the rate at which house prices rise (or fall) play a part in this.
The rate of change in house prices and therefore affordability varies greatly between countries. Data from Eurostat shows that of the 24 member countries that have quarterly house price data, 12 had increases in year to the third quarter of 2013 and 12 had falls. Further, only seven had price increases greater than inflation over this period and 17 recorded falls or rises lower than the rate of inflation.
This variability in house prices between countries fits with the findings of studies of house prices over long periods of time. The book Safe as Houses, for example, finds that, while house prices can rise above inflation for many years, there is a long term tendency for them to eventually fall to a level closer to an inflation-adjusted level. Also this 2010 IMF study argues that house prices can be very volatile, rising for long periods but falling rapidly in subsequent years.
Do not over commit
Being aware of the long term volatility of house prices and the financial risk involved in buying can be important in managing money. Especially given the decision on where and how to live is often emotionally-charged.
When considering whether to buy or rent, it can pay to consider a wide array of information and try not to be restricted to the movement in house prices only over recent years.
The thinking trap known as representativeness – using a mental shortcut to jump to a conclusion – warns that this can lead to making decisions that may not work to our best advantage.