Nearing the Limit
The housing market has suffered from excess demand and limited supply for years, causing a sharp increase in home prices. Add continually increasing interest rates to the mix, and eventually something has to give.
The turning point may have arrived.
The S&P CoreLogic Case-Shiller report shows that home prices are still rising, but at the slowest pace in almost two years. For almost a year, the National Case-Shiller Price index has risen by an annualized rate over 6% – well outpacing wages as well as inflation. Meanwhile, existing home sales were down 3.4% in September and down 4.1% from the previous year, according to the National Association of Realtors (NAR) – the lowest mark since November 2015.
An out-of-balance market may be adjusting toward normalcy. That's potentially good news for you, if you keep your finances in decent shape.
Out of Sync
The housing crisis and Great Recession put potential homebuyers in a difficult position. Home prices collapsed, while interest rates reached historic lows as the Federal Reserve cut benchmark rates to near zero. Unfortunately, the effects of the recession and stricter lending requirements meant that few people could take advantage of these favorable buying conditions.
Many existing homeowners were trapped owing more than their home was worth, unable to refinance or sell – while prospective homebuyers had insufficient credit or funds to make a home purchase.
As the economy recovered and credit loosened, home buying demand increased – but potential buyers were squeezed in several directions.
Interest Rates – The Potential Last Straw
Since March 2012, home prices are up approximately 60% while household wages are up by only 30%. According to the St. Louis Fed, thirty-year fixed mortgage interest rates over that time have risen by almost a percentage point. The current 4.86% rate is approaching the 5% mark, a psychological threshold for market watchers.
Meanwhile, the St. Louis Fed shows home inventory rising from a 5.5-month supply in May to a 7-month supply in September. Unfortunately, that doesn't necessarily translate to affordable homes. Data from Trulia shows that from Q1 2017 to Q1 2018, the inventory of premium homes (median $646,188) rose by 13.3% while the inventory of starter homes (median $180,931) dropped by 14.2%.
In short, there are plenty of homes available for people who can't afford them.
According to data from Redfin, a rise in average interest rates from 4% to 5% removes more than a third of affordable homes from tight markets like San Jose and Orange County, California. Looser markets like Denver and Miami lose 9% to 7% of their affordable homes.
Throw in more Federal Reserve interest rate increases – with the benchmark rate predicted to reach 3.4% by 2020 compared to the current 2.19% – and many potential homebuyers may just give up. Slowing growth in home sales and prices reflect that adjustment.
The effect ripples upward through the housing market. When potential homebuyers are priced out of the starter market, current homeowners who want to upgrade to better available homes can't – because it's harder for them to sell their existing home.
There's No Money In It
With increasing demand, why aren’t builders increasing starts of entry-level homes? Profit margins are poor, if they exist at all. High construction costs (materials and labor) and land acquisition costs, along with regulatory burdens, drive builders toward higher-end luxury homes – where the need is diminished.
National Association of Homebuilders (NAHB) Chief Economist Robert Dietz estimates that the typical new home racks up $80,000 of regulatory costs that are fixed and upfront. That value may be skewed by high-density, heavily regulated markets – but with the current median sales price for a new home at $320,000 (according to the St. Louis Fed), it's a large burden to overcome.
It's rare for cycles in the home buying market to perfectly align – low interest rates, availability of credit, a sufficient supply of homes, and buyers with sufficient funds and qualifications. Don't expect that to happen anytime soon, but don't wait for perfect conditions to make your purchase.
Interest rates are still low in historical terms – consider that thirty-year fixed mortgage rates weren't below 5% from 1971 until the beginning of 2009 – but they should crack the 5% mark again soon. Supply and demand will slowly correct as some give up on homeownership while the supply slowly improves. Credit is still a bit tight, but lending restrictions are loosening over time.
The only one of the above factors you can control is your own financial situation. A high credit score is key to getting the lowest rate possible in any given market. You can check your credit score and read your credit report for free within minutes by joining MoneyTips. Larger down payments allow you to avoid private mortgage insurance (PMI) and minimize your borrowing.
Adjust your budget to keep spending under control. Establish a down payment savings fund and contribute to it regularly. Always pay bills on time to keep your credit score high. Assess your housing needs and use online calculators to determine the amount of home you can truly afford – avoid overreaching just because you have some money in the bank.
Home buying windows of opportunity are rare. When you find your new home, you want to be in the best position possible to buy it – regardless of market conditions.
MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.