Navigating the Current Housing Market
The durability of the now two-year-old housing boom has upended just about everything about the process for buyers and sellers.
Despite consistently dwindling inventory and rapidly accelerating mortgage rates, the time houses spend on the market is close to historic lows. The average is 47 days – but there are markets where the list/open house/offer timeline can be less than a week.
How can a buyer find an edge? First by understanding the current housing market, then setting realistic expectations.
The Current State of the Housing Market
Although mortgage rates are the highest they’ve been in the last ten years, they are in line with the long-term averages over the last 40 years. There is a strong link between rates and buyers. For every 1% decline in mortgage rates, you will see on average five million new buyers enter the market.
Supply and demand is posing a challenge to housing that leads us to believe we will not see a significant price decline in future home prices, but instead see home prices stabilize. The outlook for the inventory issue we are experiencing will likely worsen. With nearly 80% of current mortgage borrowers’ rates below 4%, they are not enticed to move from their current home to finance at a higher rate. While existing home inventories are low, new home sales and new home starts are seeing a noticeable increase.
May housing starts rose 22% from April, which speaks to the scarcity of options for buyers in the market. In May, active U.S. listings were approximately 580,000 – while this is an increase for the past two years, it still remains nearly 50% below the number of houses, condos, and townhomes that were on the market just five years ago. Home prices are prevented from sliding so long as the supply of homes on the market remains low.
Set Realistic Expectations
With a quickly changing market, you need to understand what you can afford and when. Consider:
Closing costs – 2-5% of the home’s value
Down payment – 20% standard means you don’t have to pay private mortgage insurance.
You don’t always have to put a full 20% down if it makes sense on the monthly payment not to.
Credit score – this will impact your mortgage rate
Taxes – will you escrow your property taxes and insurance payments?
How Much House Can You Afford?
Your monthly mortgage payment, including taxes and insurance, should not exceed 25% - 35% of your total monthly bring-home income. Once your payment exceeds this number, you begin to approach being “house poor” and lack the free cash flow to support the lifestyle you’re accustomed to. Keep this Debt-to-Income (DTI) ratio in mind when calculating how much house you can afford, it will come into play again when you apply to be pre-approved.
Current interest rates can be intimidating when you consider how low they were just two years ago, but these interest rates should not be the only deciding factor when determining if you should buy a home today or not.
Let’s say you finance today with a 30-year mortgage at a rate of 6.5%, there may be an opportunity within the next few years to refinance your loan to a lower interest rate. Also, within a few years, you will have increased equity in your home, allowing you to remove PMI from your monthly payment – assuming you did not put 20% down during your initial purchase.
The value of the home is the biggest unknown. This requires thorough research of your target area and an understanding of what comparable homes are selling for. The guidance of a real estate agent is critical in an ever-changing market with an outlook that could be very different today than it was even two months ago.
Time Horizon
Whether you scroll through Zillow for fun or have a strict timeline, your home purchase goal has a time horizon. If yours is within 18 months you’ll want to make sure your cash down payment is kept in a risk-free asset like an online savings account or money market fund.
Make Yourself Competitive
What used to be a rarity – the all-cash deal – is becoming more common in this market. If you’re not able to Venmo the home’s owner, at minimum, you need to get mortgage pre-approval. This means you need an understanding of your maximum budget based on your monthly payment and what the bank is willing to lend you before you start house shopping.
Taking the next step of a pre-underwritten loan may also be a good idea. Pre-approval is not a guarantee that you’ll get a mortgage. Pre-underwriting means that the mortgage company has evaluated your financials and committed to writing a mortgage up to a specified amount.
The Lending Process
Mortgage lenders generally want to see the past two years of income and work history, and if you receive W-2 income, you’ll most likely need to provide recent pay stubs and W-2 documents. Self-employed individuals must jump through a few more hoops. In addition to your work history, you’ll likely have to submit tax returns and other documents to verify your income – lenders typically view self-employed individuals as more risky borrowers (even though this may not be true).
On top of your income and employment status, lenders will want to know your debt-to-income (DTI) ratio. This allows them to see how much of your current income is going towards debt to determine how much additional debt they feel you can handle while still being able to pay them back. The DTI calculation is relatively simple as it divides your monthly income by your monthly debt payments. So, if you earn $15,000/month and pay $5,000 towards debt, your DTI ratio would be 33%. A typical number lenders are looking for borrowers to stay under is 36%.
Another strategy to use in addition to pre-underwriting is taking advantage of a rate lock. Given that interest rates are rising, a rate lock can guarantee your rate for a set period, generally 30-60 days. However, there is a tradeoff as this strategy can become expensive if you don’t find a home within the specified timeframe and have to request an extension. The fees associated with a rate lock are generally based on a percentage of the total loan amount.
Contingencies
From the seller’s perspective, an offer with no contingencies is more attractive than the same amount of money – or maybe even more money – with contingencies. An offer without contingencies increases the likelihood of the sale going through. So as a buyer, you may want to consider giving up some of the protections that are usually built-in to the deal.
Home Inspection: This protects you against something seriously wrong with the house that isn’t reflected in the price. Forgoing this means you could have hidden costs due to a serious issue that an inspection could have found and ultimately pay more than the selling price.
Appraisal Contingency: If you give up this contingency that allows you to back out of the deal, and the home appraisal comes in lower than your bid, you’ll have to make up the difference with cash. Your lender will write a mortgage for the appraised value, and no more. Appraisals are based on previous similar sales, and in this skyrocketing market, the data lag can be detrimental.
Home Sale Contingency: If you're like most homeowners, you probably need to sell your current home in order to afford your new house. Unless you've been approved to hold two mortgages, you'll need to include a sales contingency. This is an additional contingency that can make your offer less attractive when stacked up against those without such. If your new home purchase is not dependent upon the sale of your current home purchase, dropping this contingency gives you a competitive advantage.
Dropping contingencies puts you at risk in a few obvious areas, emphasizing the importance of understanding your budget and how competitive you want to make your offer. These moves are not things that you should take lightly.
Bottom Line
For a buyer, it’s a frustrating time to enter the housing market. Given the likelihood that interest rates will continue to rise and inventories will not increase dramatically anytime soon, you’ll need to be strategic, prepared, and fast-moving. Do your research, set your expectations, and get your ducks in order.
Ashlyn Prom