By now, it’s a familiar story:
Starry-eyed home-buyer hopefuls make a generous offer above asking price, waive an inspection, and put down thousands in due diligence, only to get outbid by all-cash offers or tricky technicalities.
Thousands of people have lived through similar scenarios in one of the hottest housing markets since before the 2008 bubble. And while it’s cooled off a bit, home prices are still much higher than average.
The combination of inflated home prices and low inventory has many potential homeowners wondering if now is the right time to purchase a house?
Buying a home is challenging in any environment, but especially in the current market. Does it make sense for people to hold off on their home dreams? What other factors (financial and personal) should soon-to-be homeowners consider before moving in?
Bringing Context to the Wild Real Estate Ride
Even before the pandemic, the housing market was accelerating. Between 2012 and 2019, housing prices jumped more than 50%, and now, home prices are higher than they’ve been in decades.
Data from the Federal Reserve Bank of St. Louis notes the median sales price of a U.S. home is $374,900 — $52,400 more than the same time last year.
And these houses aren’t on the market long.
According to Zillow, 2020 broke records for home sales timing, averaging just 25 days before going under contract. In 2021, the trend continues. In April, 47% of homes were on the market for as little as one week before sellers accepted an offer!
What explains the housing frenzy?
Why People Want Houses
The pandemic certainly was an influential factor. Since people did everything at home for nearly 18 months (work, exercise, eat, entertain virtually, learn, teach, etc.), more space became a priority.
People often left big cities for the luxury of more space in smaller towns. These moves drove demand way up, while inventory went way down — a classic supply and demand dilemma that’s caused home costs to surge.
In addition to demand, home-buying became much more affordable with historically low mortgage interest rates. Bankrate found that today’s average interest rate on a 30-year fixed mortgage is 3.13%, almost two percentage points lower than the 2019 average.
Armed with more money and a strong desire to stare at a different set of four walls, people took house hunting to new levels.
It isn’t just home buyers facing inflated costs; other building-related expenses have increased like material prices, labor shortages, and local regulations, making current homeowners wary of putting their house on the market in fear of not being able to find a new home themselves.
Many are concerned about another housing bubble, like the infamous 2008 crash. As of now, there isn’t definitive data to support those concerns; in fact, home prices may continue to rise.
What does all of this mean for those in the market to buy?
While the housing rush will likely plateau, buying a house encompasses so much more than the list price.
Four Questions Future Homeowners Should Consider Before Buying a House
Even in today’s climate, purchasing a house is still a monumental personal finance decision and should be done with care and attention. Here are some top things to think about before buying.
Find out if you have enough.
1. Do You Have a 20% Downpayment? (And Why it Matters so Much)
Brokers and realtors may entice you with options to limit your down payment to 10%, 5%, 3%, or even 0% in exceptional cases. But less cash up front comes with a pricey catch: private mortgage insurance (PMI).
If you want a conventional loan and can’t put 20% down, many lenders require you to purchase private mortgage insurance to protect their interests if you stop making payments or default.
You stop paying PMI once you’ve acquired 20% equity in your home.
PMI isn’t just a nuisance; it can significantly increase your monthly costs and the total costs over the life of the loan. The average price of PMI can range from 0.6% to 2% of the original loan amount. The smaller your down payment, the longer you’ll be on the hook for this extra monthly expense.
Putting more money down up front can also decrease your monthly payments. Most notably, you’ll pay less in interest over the life of the loan. A fascinating example from Zillow found you could save more than $54,000 in mortgage insurance and interest over the life of a 30-year fixed loan by putting 20% down instead of 5% (on a $300,000 home with a 4.25% interest rate).
Properly saving for a down payment isn’t easy. If the median sales price for homes this year becomes $375,000, to achieve 20% down you’d need $75,000. How can you build up these funds?
- Your credit score. This is one of the most significant factors lenders will evaluate when looking at your loan application. Credit scores of 740+ tend to qualify for the lowest interest rates, so do what you can to boost your credit before house hunting!
- Have an estimate of what you’d like to spend. This will help you better understand how much to save. There’s a major difference between a $250,000 and $500,000 loan. Here’s where to find how much house you can afford. As a general rule, housing shouldn’t exceed 30% of your monthly cash flow.
- Create a home-buying timeline. When are you hoping to buy a house? Does it mark a significant life transition like marriage, moving for a job, school district, etc.?
- Redirect current spending where it makes sense. If you hope to move soon but still need extra cash, try to mindfully stretch your budget. Maybe stop dining out for a few months or pare back on other non-essential frills.
- Start saving and investing today. There are several ways to build up your down payment fund. Perhaps you’ll keep some money in high-interest savings accounts, CDs, money market accounts, and other money you can invest in a brokerage account. Your advisor can help you create a personalized strategy for you.
Keep in mind that your down payment isn’t the only out-of-pocket expense to prepare for when buying a house. You’ll also need to factor in closing costs, which can be 1% to 3% of the home’s price. Closing costs include appraisal fees, title searches, surveys, taxes, origination fees, and others.
If you’re eyeing a lower interest rate, you may also want to buy mortgage points, which are upfront costs that can lower your rate over the life of the loan. You can also consider applying for a 15-year mortgage instead of a 30-year mortgage. You’ll likely receive lower interest rates, but your monthly payment will be higher.
2. Are You Prepared for Ongoing Financial Costs (Besides Your Mortgage)?
You know about mortgage and interest payments, but that’s just the tip of the financial iceberg for ongoing expenses.
- Homeowners insurance. The national average runs $1,585 per year but varies depending on your state, house size, and coverage needs.
- Property taxes. This annual expense is widely dependent on where you live. Some states like New Jersey are infamous for their sky-high property taxes, while others like Hawaii and Colorado boast relatively low property taxes. If you don’t have an escrow account, you’ll have to save extra money to foot the bill each year.
- Utilities. While you may be used to paying for electricity and gas while renting, other utilities like water, sewer, and garbage will likely be extra with a home.
- Home maintenance. Your big-ticket item and maintenance costs will likely shift each year. Minor plumbing or electrical issues may not set you back much but replacing appliances, installing a new roof, or updating HVAC systems can be costly. You’ll also have other tasks like cleaning gutters, lawn care, pest control, and more.
- Security systems. Many people install security systems in their homes. The initial equipment purchase and installation may only be a few hundred dollars, but you could see $20 to $50 per month in ongoing monitoring services.
- Home Owners Associations (HOAs). When you move into a condo, townhome, or house in specific neighborhoods, you may have to belong to an HOA. HOAs add extra costs that average about $200 to $300 per month. Many HOAs offer excellent benefits like community spaces, patios, landscaping, swimming pools, exercise facilities, and more. Typically, the more benefits, the higher the payments.
The bottom line is that homeownership, while rewarding, is expensive. Be sure you can easily afford these ongoing payments and you aren’t overspending on your home.
3. Are You Tied to the Location?
Many people buy houses thinking it’s the “next step” or a better deal than renting because they can build equity. But that’s not necessarily the case, especially if you’re not sold on the area.
Given the significant upfront costs of buying (and selling) a house, most homeowners find it financially beneficial to remain in the home for at least five years. Here’s why:
- If you want to avoid capital gains tax on the sale of your home, you’ll need to stay put for at least two years. You don’t have to pay capital gains on your primary residence on the first $250,000 (if filing single) or $500,000 (married filing jointly).
- The cost to sell your house is also expensive — roughly 15% of the home’s purchase price — and includes things like realtor fees and commissions, home improvements, closing costs, and moving expenses.
This timeline is just an estimate. There are several reasons why you may need or want to move sooner: job relocation, school district considerations, outgrowing your house, etc. If you relocate for a job, see if your new employer offers any financial assistance when selling or buying a house in your new area.
When considering a home purchase, ask yourself:
- Do you see yourself staying in this location for the foreseeable future?
- Are you happy with your job, and would a job or career change take you out of the area?
- Are there good amenities like restaurants, bars, entertainment, gyms, shopping, etc.?
- Is it near family, friends, community, places of worship, and/or support systems?
- Is it in your children’s school district or a good school district if you’re planning on having kids?
4. How Does the Purchase Align with Your Long-term Financial Goals?
Buying a house is a significant decision, one that shouldn’t be made casually. You want to ensure that the purchase will help further your goals. In short, uncover your “why.”
Knowing why you want to buy a house will help you choose with both eyes wide open.
- What opportunities will a home open up for you?
- Are you ready to put down roots?
- What does owning a home mean to you, and how can it help further your goals?
It’s best to make spending decisions with clear goals to bring more intention and purpose to the process.
Is Buying a House Part of Your Financial Plan?
For many, buying a house is the American dream. There is pride, promise, and opportunity that comes with homeownership, but there are also essential costs to consider.
Whether you’re looking for your first home or dream home, an Abacus advisor is here to help. If buying a house is one of your financial goals, we’d love to create a plan that lets you reach that significant milestone.
Let’s work together so we can show you what is truly possible with your money. Schedule a call with an Abacus advisor to get started.