Holding payment budgets, loan terms and other demand/supply factors equal, an increase in which factor most directly reduces mortgage borrowers’ purchasing power?
Correct Answer
B) Interest rates
With a fixed payment budget and otherwise unchanged loan terms, higher mortgage rates reduce the loan amount a buyer can afford, which can weaken effective demand. This is pressure rather than a mechanical prediction of a specific market-price change.
Why This Is the Correct Answer
Option B is correct because, with a fixed payment budget and the same loan terms, a higher mortgage rate reduces the loan amount a buyer can afford. The level of interest rates affects the demand for real estate and real estate value. Rising rates therefore put downward pressure on effective demand, though they do not mechanically set a specific price change.
Why the Other Options Are Wrong
Option A: Employment levels
Option A, employment levels, tends to raise purchasing power when it increases. More people working means more households able to qualify for and afford mortgages.
Option C: Household income
Option C, household income, increases purchasing power when it rises. Higher income supports larger payments, which is the opposite of the effect asked about.
Option D: Population growth
Option D, population growth, adds potential buyers and tends to increase demand. It does not reduce the amount an individual borrower can afford to borrow.
Rates up, reach down
When rates go up, a buyer's reach goes down because the same payment covers a smaller loan.
How to use: Use this phrase to recall the direction of the interest-rate effect on purchasing power.
Exam Tip
Identify which factor works against buyers when it increases. Employment, income and population growth usually help demand when they rise.
Common Mistakes to Avoid
- -Assuming higher rates increase buyers' purchasing power
- -Treating rising employment or income as reducing demand
- -Treating a rate increase as setting an exact price change
Concept Deep Dive
Analysis
This question tests how interest rates affect buyers' purchasing power. With a fixed monthly payment budget and otherwise unchanged loan terms, a higher interest rate means the same payment supports a smaller loan. The other choices are factors whose increase would tend to strengthen demand, not weaken it.
Background Knowledge
Effective demand requires both the desire to buy and the ability to pay. For mortgage borrowers, the interest rate strongly influences how much a given payment can borrow. Financing cost and availability are significant determinants of both demand and supply.
Real-World Application
A buyer budgets a fixed monthly payment. After mortgage rates rise, the lender approves a smaller loan for that payment, so the buyer must look at lower-priced homes. An appraiser may see fewer buyers in the upper price range as a result.
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