Gearing up to buy a home is an exciting time. It feels as though the opportunities to find the perfect house are endless. Days at work are spent with a second browser open scouring listings. Your inbox is flooded with emails from your family and real estate agent.
While it is easy to get swept up into the excitement of the search, take a step back and ask yourself, “Is now the time to buy?”
For a large and (semi-)permanent purchase like a home, the decision-making process involves balancing both financial and personal considerations.
You may view a home purchase as a purely financial investment. If that is your motivation, two major economic drivers will influence your decision: housing prices and interest rates. Of course, we all hope that when we buy, both interest rates and housing prices are at historical lows.
In theory, the relationship between those indicators is inverse, due to the interaction of supply and demand. As interest rates drop, buyers flood the market to take advantage of lower monthly housing payments and drive up home values. In reality, there are many more players at work.
Drivers of the Housing Market
The first step in making a balanced decision is to research your housing market. With the housing crisis more than five years behind us and regional economies booming around the county, homes are expensive. However, local markets behave independently. A few relevant factors to research in your area include:
· Historic Housing Prices
Home prices are impacted by many factors. Factors such as an excellent school district lead to higher and more stable prices over time. Other neighborhoods may be up-and-coming and have more variable pricing over time.
· Rental rates
If the cost to rent is rising, more people may decide a monthly housing payment is a better use of their funds. These additional homebuyers will drive up the cost of homes in the area.
· Population growth
How many people move to this city each year? Is this trend expected to keep up over the next three, five, or ten years? An influx of people translates to housing shortages and increased prices, both for rentals and purchases.
· Local economy
What industries dominate the local scene, and how are they performing? Are they robust and viable, or are they prone to bust? Research unemployment rates and new job creation over time. Also, find out if any new developments are planned in areas where you would like to live. For example, if plans exist for a new retail center, condo development, or public attraction such as a park, library, or subway stop, all surrounding real estate prices are likely to increase.
· Development constraints
Does your city have space for more housing? Areas may be constrained from further development by geographies such as mountains and oceans, or even laws and local politics. Local construction defect laws may disincentivize new housing development, as some argue they make it too easy for homebuyers to sue over structural problems. These constraints will likely hike up prices, especially if demand for housing is going up over time.
· Home characteristics
Specifically research how home values are changing for the type of home you are interested in purchasing. Price behavior of home prices from $300,000 to $600,000 will not behave identically to homes from $600,000 to $900,000 (which likely require a jumbo mortgage). Likewise, price behavior for single family homes will not necessarily track price behavior of condos or multi-family units in the same area.
The Interest Rate Environment
Interest rates are much more complex. The United States is a capitalist economy, but the economic system is still partly controlled by the government. You can consider it “managed capitalism,” which is designed to add stability and security to the economy.
To impact interest rates, the Federal Reserve sets a target level for the rate that banks charge one another to lend funds overnight, called the “federal funds rate.” The committee which determines the rate meets eight times a year. While mortgage rates are largely determined by market movements, changes in the federal funds rate can have a large effect. If it is more expensive for banks to borrow money from one another, they pass along those costs to customers.
The Fed uses various methods to impact mortgage rates. It buys mortgage bonds in order to increase their price, which puts downward pressure on rates; if lenders can sell mortgages on the secondary market for more money, the rates offered to borrowers decrease. Conversely, when the Fed sells bonds, they lower demand, prices subsequently drop and mortgage rates move upward.
One method to predict changes in mortgage interest rates is to track movement in the yield of U.S. 10-year Treasury bonds. Due to refinances and sales, the average lifespan of a 30-year fixed rate mortgage is around 7 years. Mortgages are usually bundled and sold in mortgage-backed securities. The yield on these securities is correlated with yield on 10-year U.S. Treasury bonds: when bond yields go up, mortgage rates go up, and vice versa. U.S. Treasury bonds are backed by the “full faith and credit” of the United States. Mortgage rates are higher because they are a riskier investment.
This is by no means an exhaustive list of factors that impact interest rates. Mortgage rates are fairly complex, and are even more complicated for adjustable rate mortgages. Comprehensive research and speaking with financial professionals can help you discern if interest rates are favorable. Refinancing alleviates some of the burden of having a high interest in the short-term, but isn’t always an available option in the future depending on the borrower’s circumstances and the availability of credit.
Impact of Personal Priorities
Do you plan on having kids and want them to grow up near their cousins? Is your mother sick and needing assistance? Is your son unchallenged in his current school district?
Do not discount the importance of emotional factors. You may be willing to buy in an expensive market or lock in a high interest rate to address your family’s priorities now. The question is, will a home that is a perfect fit today still satisfy an ever changing set of needs and priorities three years from now? Ten years from now?
Weighing these intangibles in your decision is crucial. Because your monthly payments in the earlier years are mostly interest, from an investment perspective, the longer you stay in your home, the better.
At a high-level, the market today is a tradeoff between low interest rates and high home prices. The goal is to buy smart by considering both financial and personal drivers. Weigh the future in your decision today. Most importantly, you do not want your housing debt to become a burden to your family. Do your research to ensure that the house of your dreams fits within your real life budget.