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 year and a half, the housing sector has been inarguably one of the most robust and healthy parts of the economy. While other sectors crumbled or stalled as the coronavirus swept across the country, housing surged. In fact, prices are at an all-time-high.
And that’s precisely the problem. Some industry watchers are convinced we’re on the edge of the precipice, that a crash—one with inevitable collateral damage—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? Among observers, how much cool-headed analysis has actually been applied to understanding the specific conditions affecting the housing market of 2021, as opposed to, say, evoking the frightening specter of 2008’s financial crisis and assuming that a similar escalation of prices will yield a similar result? 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 two 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’ve witnessed over the last 18 months (especially once the country emerged from lockdowns).
During just 2020, mortgage rates fell to all-time lows on at least 13 different occasions. Rates have see-sawed in 2021 but have remained low throughout, with six of the first eight months of the year recording average mortgage rates below 3% according to Freddie Mac. Clearly, this is unchartered territory.
Finally, the prognosis for affordable mortgage rates over the next 12 months remains bullish. Rates may not match the record lows we’ve witnessed recently, but they will likely remain markedly lower than those of previous years and homebuying enthusiasm will remain strong.
Additional factors driving the frenzy
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.
Supply chains and COVID-19
An important contributing factor to this shortage has been the pandemic itself. In 2020 when the economy grinded to a halt, supply chains for things like lumber and other building materials were impacted greatly. Since lumber is a crucial resource for new construction, a lack of supply predictably curtailed housing starts. Without an uptick in new construction, prices for homes have remained high, creating the ideal environment for a sustained seller’s market. Add to this, hesitant sellers who were leery of interpersonal contact or even having visitors stroll through their home in the era of COVID, and you have the perfect storm for diminished listings and a captive marketplace.
The pandemic effect: more need of space, more homebuying
When the COVID-19 virus swept through the U.S., many workers lost their jobs as certain businesses were forced to close. However, many more—especially those working in offices—were simply told to work remotely for the time being. And as we all know, working remotely means “working from home.”
Interestingly, when people begin to work from home, day in and day out, it’s not uncommon for many of them to have a unique epiphany—the need for more room. Typically, this manifests itself as a desire for a bigger work space, a bigger home, a bigger everything. All that and outdoor spaces as well. This has affected the market in enormous ways, creating a new shift to the suburbs and a desire for houses, not just apartments. In combination with historically low interest rates, this has created an impetus to “buy now” and keep home prices ticking upwards in many areas.
Exuberance yes, speculation no
As we’ve described above, the current housing market has experienced a dramatic rise in sales prices over the past year or so. According to a recent survey, the median home sale price has risen to $374,900—that’s a momentous $50,000 increase from where prices stood just 12 months earlier. To properly understand this ascent, we need to look at buyer sentiment.
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 simple positivity within the marketplace. Taking advantage of opportunistic conditions and purchasing homes because value, need and desire merge in a satisfying way. The past 18 months 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. Who wouldn’t be exuberant?
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 through dangerously structured subprime adjustable rate mortgages (ARMs). Or overconfident homeowners tapping into home value through a home equity line of credit (HELOC) or home equity loans to buy expensive nonessential items with the hope of recouping this loss of equity through ever-ascending home prices. 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.
In addition, because fixed rates are so low ARMs are less attractive and 15- and 30-year rate mortgages are increasingly popular. 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.
Who are the untapped buyers?
A peak into national demographics suggest that many new homebuyers are lurking in the shadows of the market, preparing to purchase a home. One need look no further than the millions of millennials who are purportedly waiting for the right time to buy.
While it’s been widely reported that millennials appear more reluctant than previous generations to plunge into homeownership, many are simply waiting for housing prices to subside a bit before making the big decision. However, many more are active participants in today’s marketplace. According to one recent report, millennials actually comprised the largest group of homebuyers in 2020 with a 38% share of the market.
Hispanics, too, constitute a massive piece of the homeownership pie that’s set to explode over the next 20 years. Housing experts predict that by 2040 up to 70% of all new homebuyers will be Latino. Finally, female homeownership—especially in the form of single women—has been increasing steadily in recent decades, comprising almost 1 in 5 homebuyers in 2020.
As you can see, a range of populations within the U.S. remain excited about the prospects of homeownership—and not just somewhere vaguely down the road, but right now. These prospective homeowners are engrossed in the current market: browsing for listings online, contacting mortgage providers and trying to find the best rate available. Clearly, demand is as steady as it’s ever been.
What’s a first-time homebuyer to do?
While millions of homes were bought and sold over the past year and half, 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*
Trust the process, stay positive and be cognizant that things may take a while. Realtor.com reports that the typical home spent only 39 days on the market in August, (compared to 56 days the previous year), which is great for the seller but doesn’t give you a ton of time to sift through the numbers and make a decision. 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: historically low mortgage rates, all-cash bidding wars and sale prices in huge swaths of the country that are going through the roof. 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. Inventory is expected to pick up soon and as we move into the fall and winter some sellers will undoubtedly look to make deals and cut prices. While it’s unlikely you’ll be purchasing at a discount in this market, that doesn’t mean your new home won’t yield a tidy profit five or 10 years down the road when it’s time to sell. That’s the simple principle of sound investing.
Our advice: Keep your eyes on the prize and ignore the noise. Enjoy the boom and forget the bubble.
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