As the housing market heated up during the pandemic, many would-be homeowners found themselves unable to buy despite making multiple offers or waiving inspections. Now, rising mortgage rates and low inventory may have them feeling quite depressed. In May, consumer sentiment about home-buying reached an all-time low. And yet if you can afford it, this actually might be a good time to consider buying a house.
That might seem surprising. Home prices have soared since 2020 and mortgage rates have been rising steadily in 2022 — the average rate for a 30-year fixed mortgage was about 3% in January 2022, but today is about 7.08%. With inflation eating into earning power, real household incomes have been stagnant since 2019. The newest numbers from the National Association of Realtors for housing affordability, roughly measured as the ratio of an average mortgage payment to average incomes, won’t be out until Nov. 10, 2022. But the August report was grim, and I doubt the November affordability numbers will be any better.
Here’s the good news. Prices are starting to edge down in 98 out of 148 major regional housing markets. Buying an asset when the price is falling is generally a good thing. Buying a home now when mortgage rates are high and housing prices are falling means as mortgage rates stabilize or even drop, your house value will more likely inflate than if prices were rapidly increasing and mortgage rates were increasing.
Rising mortgage interest rates and a potential recession may seem like bad news, but these trends could benefit would-be home buyers by cooling demand and dropping prices further, especially if the buyers are confident they won’t lose their jobs and income.
Of course, a would-be home buyer must consider other important criteria besides housing prices before buying a house. Other important decision factors include having at least 20% for a down payment; whether you will live in the property for more than five years; and whether your monthly payment will be lower than 30% of your gross income.
Another important factor is whether you’ll be able to pay off the property in 15–20 years. I advise a 15-to-20-year mortgage, rather than a 30-year mortgage, especially when rates are high. A shorter mortgage helps curb the expense of the house over time. On a $500,000 loan, a 30-year mortgage at 7.08% would cost you over $707,000 in interest. The same amount borrowed on a 15-year, 6.28% loan would cost you only about $273,000 — about $434,000 less. Put that in your retirement fund instead!
Of course, there are situations where you might be better off renting. One of the best ways to get a feel for whether you want to buy or rent is to compare the cost of a home in your area to what it would cost to rent a similar property. The rule of thumb says if the ratio of homeownership costs to annual rental expenditure is under 16, definitely buy. If the ratio is over 20, then the house is probably overpriced and renting is the better option. Online calculators can help you figure out the house price-to-rent ratio; one of my favorite calculators is from Dinkytown.net.
You also need to predict how much you could earn if, instead of buying a house, you chose to invest the money used for your down payment. I recommend starting with an assumption that money would earn 4%–5% over the life of the mortgage. By comparison, I’d recommend that you assume the value of the home will not appreciate more than 1% over inflation. That may sound conservative, but I bought in August 2007 in New York City, and the appreciation averaged 0 for the next 8 years.
Be clear-eyed about how much property maintenance you will have to pay — many first-time home buyers forget about that. Perhaps assume 1% of the purchase price every year. A $1 million house could require $10,000 in yearly maintenance.
So, should you buy a home now? If you can meet the criteria above, I suggest going forward despite the high interest rates. After all, if rates drop you can always refinance.
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