Why homeownership is still a smart financial move
Sir Issac Newton’s groundbreaking theories on gravity have had profound implications for generations of humans. Ask any casual student of science. The manifestations of his discovery are everywhere, affecting our lives in both seen and unseen ways.
But one question remains: Does Newton’s famous axiom, “What goes up, must come down” apply to the housing market? And if so, are we still “going up,” or are we about to “come down”?
The housing sector: A wild ride
Over the past few years, the housing sector has been gone from being one of the most robust and healthy parts of the economy to being in crisis. While other sectors crumbled or stalled as the coronavirus swept across the country, housing surged. But as mortgage rates have risen into the 7% range over the last few months, and housing inventory has gotten shockingly low, housing has struggled. Despite higher rates, home prices have remained high.
Some industry watchers are convinced we’re on the edge of the precipice, that a crash can’t be lurking too far behind the overheated prices and the all-cash bidding wars that accompany them. In the words of certain pundits of the real estate industry, we’re in a bubble, heading for a bust.
But do these dire warnings pass the truth test? How much do the specific conditions affecting the housing market today compare to, say, 2008’s financial crisis? While economists can reasonably debate the ongoing health of the overall market, parallels to previous housing bubbles may not be the best place to start.
Home investment remains strong
Meanwhile, prices continue to climb or remain high in many regions of the country. As housing analysts know, it’s only a bubble if it bursts. Homebuying, however, continues to warrant its elevated position in our society as a key way to build long-term wealth while contributing to the well-being of communities, families and individuals. Simply stated, homeownership is foundational to American life. While housing markets will invariably go up and down over the course of several years, “home as investment” is as strong as ever.
To get a better grasp of the overall picture, let’s take a deeper look at the state of the housing market over the past few years, see what underlying conditions are pushing prices upwards, understand the role of inventory and explore the many new and diverse populations who take pride in homeownership.
We’re convinced buying a home is still a smart financial move, and despite the chatter in some quarters, now can be a great time to enter the marketplace and begin your homebuying journey.
Skyrocketing home prices — how did we get here?
As even casual observers may acknowledge, the real estate market tends to move in cycles: periods of weakness (stagnant or even declining home prices) followed by periods of growth where home prices demonstrably increase. Throw in seasonal fluctuations, homebuyer confidence and always-tempestuous interest rates and you begin to see the broad outlines of the marketplace. There are many contributing factors to the ups and downs of home prices.
The housing sector, of course, is just one of several important sectors within the U.S. economy, and as such, its performance has reverberations within the larger economy. Additionally, housing can be a leading indicator of economic activity—specifically “housing starts” or new residential construction—meaning that its relative strength or weakness can indicate important trends in the national economy several months out.
For our purposes, we’re mostly interested in home sale prices—what it says about buyers, sellers and housing value, today and in the months and years to come.
COVID-19 and plunging interest rates
The preconditions for a steady rise in home sale prices actually date all the way back to 2019—well before COVID was even a rumor. The housing shortage that had begun in the aftermath of the subprime mortgage crisis a decade prior was continuing to tighten the market, providing precious little supply for the healthy customer demand. Interest rates, too, were already well below 2017-2018 levels.
Then in March of 2020, COVID-19 arrived and turned everything upside down. Reacting to the sudden stifling of the economy brought on by the pandemic, The Federal Reserve rushed to put in place new monetary policies that would stem panic and support increased cash flow. They also made good on promises to buy up massive amounts of Treasury bills and mortgage-backed securities (MBS), helping to stabilize the housing industry and reduce mortgage rates.
The undeniable influence of mortgage rates
The role of mortgage rates in this whole saga cannot be overstated. Low mortgage rates are the gasoline that fuel the homebuying fire—that was true 30 years ago, it was true 10 years ago and it remains true today.
When rates dip, the homebuying public takes notice. A modest reduction elicits serious interest from homebuyers; an outright plunge ignites the kind of frenzy we saw in 2020 and 2021.
When the Fed raised interest rates to battle inflation starting in 2022, mortgage rates started rising as well. As of this writing, they've been hovering near 7% for weeks. This has led to an affordability crisis, when homebuyers can't afford the monthly payments needed to realize their homeownership dreams.
Lack of inventory driving home prices
After interest rates (which fuel consumer demand), the biggest factor driving an increase in home sale prices is the lack of inventory. As we mentioned above, this is not a new problem. However, in a hot housing market inventory shortages invariably drive up home prices, resulting in a situation where supply in no way meets demand.
Exuberance yes, speculation no
As we’ve described above, the current housing market has experienced a dramatic rise in sales prices over the past few years. According to a recent report, the median home sale price has risen to $371,200—that’s a momentous $50,000 increase from where prices stood about two years ago, but at a similar point to where they were the previous year. To properly understand this ascent, we need to look at buyer sentiment.
Exuberance
First of all, there’s good exuberance and bad exuberance. The financial dot-com bubble of the 1990s was famously defined by Fed chairman Alan Greenspan as suffering from “irrational exuberance,” implying there was a psychological basis for a speculative bubble divorced from fundamentals in contrast to real value of an investment. This term was later applied to the financial crisis of 2008 as well.
Good exuberance, on the other hand, can be seen as taking advantage of opportunistic conditions and purchasing homes because value, need and desire merge in a satisfying way. The past few years have certainly seen an emergence of unique conditions that have unleashed incredible homebuying demand. Buyers are well financed and are hungry to own. They aren’t here to flip or turn a quick profit; rather, they’re excited to invest both in value and in a way of life. They’re looking for an improved living space— a hybrid space where they can both work and live—and in many markets they are willing to pay for it.
Speculation
Speculative sentiment—a market expectation that ascribes exaggerated value to assets (homes) not supported by fundamentals—was one of the main culprits of the 2008 housing bubble and resultant financial fiasco. That doesn’t seem to be the case in this market. As previously stated, people are buying because they see it as a great investment over the long haul. This isn’t about underfinanced individuals recklessly purchasing homes they can barely afford . No, this time it’s different.
Property owners actually possess record levels of equity in today's housing market (levels that jumped by $1 trillion between 2019 and 2020). In addition, many lessons were learned from The Great Recession. Most notably, due to the reforms spelled out in the 2010 Dodd-Frank Act, lenders have introduced tighter standards for home purchases in terms of debt-to-income ratio (DTI), employment and credit scores. In short, borrowers are better vetted.
While it’s unlikely every last speculator has been weeded out from the marketplace, the preconditions for a housing bubble just don’t seem to be there on a mass scale. Across the real estate index, buyers, sellers and mortgage providers are more savvy, more prepared—and more thorough.
What’s a first-time homebuyer to do?
Not everyone has found it easy to participate in this climate of rising prices, low inventory and daunting competition that manifests itself in heated bidding wars. Accordingly, buying a home today poses certain challenges, especially for first-time homebuyers. Existing homeowners can always leverage their current home for down payment and other costs. First-time participants have no such luxury.
Let’s review a few things you can do to seize an advantage and make homebuying in today’s market more affordable and less stressful.
HOW TO WIN THE HOMEBUYING PROCESS:
- Get organized at the beginning
- Set a (price) limit and stick to it
- Don’t consider compromise an ugly word
- Check out first-time homebuyer programs
- Consider an FHA loan
- Consider a loan from Fannie or Freddie
- Stay upbeat
Get organized at the beginning
Sounds pretty obvious, right? While most people take homebuying seriously, winning at organization can help you win at the closing table. Buying a house is not a casual endeavor and the more you can have everything clarified in advance, the more successful you will be. This means getting your finances in order, holding off on big purchases and choosing a real estate agent you are aligned with and can engage with effectively. Same with lenders. Do your due diligence. Ask around. We’re confident you’ll hear great things about our overachieving loan officers, our competitive rates, our seamless journey from application to closing.
Set a (price) limit and stick to it
We get it; you’ve fallen in love with a house and must have it—at any cost. The only problem is your income and your assets won’t allow it. Or even if they do, you’re wandering out of your financial comfort zone where bad things tend to happen. Our advice: Set a limit and do not deviate. In fact, set a budget and then look at homes 10-20% below that. Bid against other buyers if you must, but always be prepared to throw in the towel when your budget has been exceeded. Don’t worry, even in this market there are always other properties.
Don’t consider compromise an ugly word
While each purchase is unique, it should be said upfront that compromise may be necessary. That is to say, compromise that is healthy. Many people are waiving contingencies in this market as a means to appease the seller and make their offer more appealing. However, this is probably not where you want to compromise (home inspection comes to mind). But there are some things you can probably negotiate on, give in a little to make the deal work. Perhaps you’re unhappy with a cracked sidewalk or an HVAC system that will require fixing. If you love the house, you may want to pick your battles. You won’t get everything—it’s a negotiation after all—but you’ll doubtlessly get some of what you want, most importantly the home itself.
Check out first-time homebuyer programs
Homeownership is a cornerstone of American life, and as such, there are many forces working to make buying a home easy and affordable. One way to ensure you’re getting the best deal is to explore the many first-time homebuyer grants and programs. Some are for specific communities like those who serve in the military, while others may be targeted to Native Americans, those with lower incomes and many who are simply just trying to buy a home for the first time.
Consider an FHA loan
You’ve found a home now you want to procure the financing. While less than 10% of all homebuyers in 2020 chose an FHA loan, of those who did, 83% were first time homebuyers.
FHA loans (from approved lenders) come with some very appealing benefits and lenient requirements for first-time homebuyers. These include a low down payment option of 3.5% if your credit score is above 580 and reasonable 10% down payment options if your credit score falls in the range of 500-579. DTI is also more generous (up to 50%). One caveat: An FHA loan will require you to purchase mortgage insurance. Once you understand what you can likely afford, explore FHA loans to see if you save any more and increase the chances of approval.
Consider a loan from Fannie or Freddie
Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that set lending guidelines and buy the majority of conventional mortgages throughout the industry, also provide incentives for first-time homebuyers. Some examples of savings and increased access that GSE loans provider include the following:
- Down payment options as low as 3% for first-time homebuyers
- Elimination of mortgage insurance once you reach 20% equity in your home
- Ability to use rental payments as evidence of creditworthiness*
Stay upbeat
Trust the process, stay positive and be cognizant that things may take a while. So if you miss out on house No.1, let it go and move on. Remember: The homebuying process can be a marathon, even if the current frenzy might make it feel like a sprint through an obstacle course. Concentrate on value and how you’ll feel when the real estate agent hands over the keys and you enter your new home for the very first time.
Big picture: Homeownership as investment
The internet continues to bubble over with breathless commentary about the housing market. As an important metric of economic health, we get it. It’s a big story: rising mortgage rates, all-cash bidding wars and "too-rich-for-my-blood" sale prices in huge swaths of the country. But that's only half the story.
The other half is what it’s always been when the economy is tethered to reality and the housing market is built on fundamentals, not inflated visions of worth: long-term value. As much as you and your family can’t wait to move into your new digs, this is also an investment. A solid investment. That’s why you do your research on neighborhoods and schools, get an inspection done and have the home appraised. You want to know what you're buying.
It’s also why you can exercise a little patience. Our advice: Keep your eyes on the prize and ignore the noise.
*Not yet approved by Rate.