It’s no secret that mortgages and the economy are inextricably linked, but what many people don’t know is how and why.
The answer can be traced back to the fact that real estate accounts for about 10% of the U.S. economy. Therefore, changes in the real estate market have broader economic implications and vice versa. In other words, the relationship between mortgages and the economy, at its most basic, is like a two-way street, characterized by clear causes and effects.
For example, if the market for real estate shrinks, not only will housing prices and values both fall, but there will also be fewer jobs in construction, contracting, realty, insurance, and so on, and so on. Given the relative lack of home equity and increased joblessness, there will be less consumer spending, and since roughly 70% of our Gross Domestic Product (GDP) comes from personal spending, that would lead to a vicious downward cycle. In other words, more unemployment leads to less spending, which leads to more unemployment, which leads to less spending, etc.
Even if the economic issues do not originate with the housing market, as long as they negatively affect consumer spending levels, housing prices will inevitably fall – when money’s tight, you generally don’t make big-ticket purchases. That, as you now know, will result in more unemployment, less spending, and the beginning of a vicious cycle.
However, it’s obviously not all negative. When the economy is strong, people will have more disposable income, which will lead to a rise in both mortgages and home sales. The more lending and spending there is, the lower mortgage rates will be.
Conversely, the housing market being especially strong could also lead to an economic boom. This is exactly what we saw in the run up to the Great Recession. As more and more people entered the market, housing prices rose and rose. Not only were people able to buy and sell houses for profit, thereby boosting economic activity, but fields tangential to real estate, such as construction, took off as well. The problem with an economic boom is that a resulting boost will usually occur at some point (cue the Great Recession).
Ultimately, any major industry like real estate will be closely tied to the economy, and most of the time there will be a clear cause-and-effect relationship between them.