If you've read the business section of a website or newspaper lately, inflation seems to be the topic everyone is talking about. The impact can be seen on everything from the price of soft drinks to gasoline. However, if you are looking to buy a home, the implications can be greater than if you just considered the price itself.
We're going to look at the impact inflation has on home buying so you can be sure of what's happening in the market right now. But first, let's start at point one.
What is inflation
Inflation is the rate at which prices rise over time. From the standpoint of a single self-serving consumer, you never want to see inflation because the money you already have in your possession is of less value than you originally made it. But from a macro perspective, some inflation is good.
In a healthy economy, there should, in theory, always be some inflation. When prices tend to rise over time, it encourages people to buy goods, services, and even houses now rather than waiting for a later date. That means a lot of work for the producers. This enables them to continue to hire employees who buy goods and services themselves.
The key is to keep inflation under control. You don't want a can of soda that used to cost $ 1.50 from the machine suddenly to cost a $ 5 bill. Another place we usually see inflation first is in the gas pump and this is also making the headlines. The US Federal Reserve has set an inflation rate of around 2% per year as a long-term goal.
Effects of inflation on housing
There are two ways that inflation affects residential real estate: the price of the real estate itself and mortgage rates.
As with any other item you can buy, house prices rise with inflation. This makes sense because the prices of the materials that houses are made from tend to rise over time. These costs are passed on by the builders.
Homeowners of existing homes, if they act as rationally as any economist would expect. It is worth noting, however, that inflation is not the only impact on house prices and that homes are prone to real appreciation over time due to a variety of factors. While we go into some of the numbers later to back the bigger trend, let's take a closer look at individual home price appreciation.
Appreciation at home
As a home appreciates, it experiences price increases that exceed inflation, thereby realizing an increase in value. There are many variables that affect value appreciation:
Condition of the house: Basically, you want your home to be in good shape. Otherwise, any valuation of your home may be subject to repairs that can delay or even terminate the transaction if repairs cannot be made within a certain period of time.
Square meters: The more space you have in this area, the higher the price compared to other homes in your area.
Bedroom and bathroom: Again, more is better. Something popular and likely in the future is office space or additional bedrooms that could potentially be converted into offices as most of America spent time working from home during the pandemic and potentially more hybrid jobs in the future. or remote work.
Location: Society may do more work in pajamas, but not everyone and not all of the time. The distance to work and public transport can still play a role. While distance to an office is not an issue, shoppers are attracted to various things such as proximity to entertainment venues, restaurants, or the beach.
As inflation rises, so should interest rates. The goal of every investor is to earn more with the investment than he invested. For this to be the case, the investment must generate at least more than the inflation rate.
Because the bonds underlying mortgage rates offer a fixed rate of return, they are not as attractive to investors in a rapidly rising price environment. You don't want to just get a 4% return on your money if inflation has increased 6% over the same period. Hence, investors will get out of bonds and put their money in things like stocks, which offer higher returns in return for increased risk.
In response, bond yields are rising in hopes of attracting investors again. An investor buys when he calculates the return is higher than his expected inflation rate. When bond yields on mortgage-backed securities (MBS) rise, so too do mortgage rates.
What is driving the market now?
Now that we know what typically affects housing inflation, let's take a look at what's happening in the market right now.
The prices are high
Indeed, house prices have risen in recent years, driven by low interest rates that make it easier for potential buyers to borrow more, at a rate that far exceeds inflation.
Overall, home prices rose 14.9% year-over-year, according to the latest Case-Shiller house price index data for April. According to the Federal Housing Finance Agency, the percentage is even higher at 15.7%. There are several reasons for this.
First, inventory is quite low, so supply is not keeping up with demand, which drives up the price of existing inventory. In relation to the current sales speed, the number of existing apartments available on the market is 2.6 months. On the sales side for new buildings, it's 5.1 months. In the perspective of an offer of 6 months, a market is considered to be in equilibrium between buyers and sellers.
Nor is the supply problem helped by people knowing that there is a supply problem. Instead of putting their home on the market and trying to move, some people are renovating their existing homes.
Although the supply on the sales side of new homes is better, most people want existing homes because historically they are cheaper. But with low inventory levels on the sell side of existing homes, that void will be filled. The average price for a new home in May was $ 374,400. Existing home prices were a median of $ 363,300 in June.
In addition to the low inventory, the prices for new homes are also likely to be higher. There are mutliple reasons for this. Even though it's a little below the recent alien highs, they're still very high. In principle, construction can begin faster than it is possible to set up this production in a sawmill. In addition, it was recently hit by forest fires.
After all, many industries have struggled to find workers, whether because of fears of COVID-19 or a mismatch between workers and employers. The construction was no exception. Higher wages lead to higher construction costs, which can lead to higher prices for new apartments.
Interest rates could go up
Headline inflation suddenly jumped 5.4% last year, according to June figures from the Bureau of Labor Statistics. This is the fastest pace since August 2008. The Federal Reserve is on record that it considers inflation temporary, the result of exploding demand now that we are in the final stages of the pandemic, while kinks in the supply chain are not yet worked out, so demand exceeded supply.
However, should inflation keep up at this rate, the Fed would eventually have to raise the key interest rate to curb inflation. If they did, interest rates would eventually rise across the economy, including mortgages.
The prices are still extremely low for the time being. Data from recent surveys by mortgage investor Freddie Mac has shared 30-year fixed rates in the high 2% range, but no one knows how long it will last. If you are financially prepared, now is a really good time to buy.
It's also worth noting that interest rates are a little lower right now as the Fed buys $ 40 billion worth of MBS every month. Although the Fed has wired that there will be plenty of warnings before changes are made to current policy, the higher demand in the mortgage bond market means that rates can be lower and still attract a buyer. If the Fed got out of the market, rates would surely rise unless other buyers filled the gap.
How inflation could affect home buying
While it might make sense in the short term that inflation drove home prices higher, if we look at it longer, prices could flatten or even fall slightly as the Federal Reserve raises short-term rates and longer-term rates tighten. Depending on where you look, some data sources seem to suggest that this is already happening. What is the reasoning?
Put simply, it's a pretty good bet that prices will be high in part because sellers know that when interest rates are low, borrowers have more purchasing power. If they go up a little, that purchasing power goes down and eventually sellers have to lower their expectations a little and prices can even go down.
How buyers should react to this market
When thinking about buying from the market today, keep the following tips in mind.
Pay off existing debts
From a lender's point of view, the debt-to-income ratio (DTI) is one of the most important qualification factors. In essence, it looks at the amount of your existing installment and revolving monthly debt payments compared to your gross monthly income. The lower this percentage, the better. This means you can afford a higher monthly payment, which can potentially allow you to pay more for a home. This could be crucial in a competitive market.
You also don't want to make new purchases on credit or open new accounts as this could increase your DTI and cause you problems during the mortgage process.
Although you may qualify with a higher DTI on some mortgage types, it is generally recommended that you keep your DTI at or below 43% in order to qualify for most loan options. By paying off your debts and keeping them in check, you can have more wiggle room in your budget.
Regardless of DTI, it is generally not advisable to spend up to the upper end of your budget. If you do, an income shock or an unexpected medical bill could get you into financial trouble. You don't want to be poor either. Being a little more conservative with home offers can help you meet other financial goals, set up an emergency fund, and have money to spare for vacation, for example.
Debt settlement goes well with this next section as it will help increase your credit score. Not only is a minimum credit score required to qualify for most loans, the higher your score, the better your rate.
In addition to paying off debt, you should, if possible, take care of negative credits such as collections and write-offs before applying. This will increase your score.
To do this, of course, you need to know them. You can get your credit report annually from any of the three credit bureaus to avoid surprises. For now, these reports can be accessed weekly as an additional awareness raising during the pandemic
Since house prices are what they are, you may not be able to get everything in your budget range, so there are a few things that are important to do. Determine if there is something in your budget to pay for and cut it off. Leave only what you need and what you can use most in terms of extras.
Second, when it comes to the house, determine the things you absolutely need, followed by the things you want most, and then what you can do without. This will help you keep from going insane and over budget in a bidding war for a house.
Save as much as you can
The good news is that you can get a conventional loan on a primary property with as little as 3% unit. However, depending on what house prices are in your area, this can still be a significant change. Additionally, it can be really worth it if you can afford the larger down payment. Aside from your creditworthiness, your down payment is the other big factor that will affect your rate.
Basically, the less a lender has to give you, the lower the risk of lending and therefore the lower the interest rate. Alternatively, you can buy down the interest rate by paying for rebate points on completion, which is prepaid interest. One point corresponds to 1% of the loan amount. When lenders offer prices, they are usually tied to a point value.
You need to factor in other closing costs as well. In addition to discount points, this can include things like title work and admission fees, appraisals, prepaid home insurance premiums, and setting up trust / deposit accounts. This can amount to 3% – 6% of the purchase price.
You can negotiate with lenders for lower closing costs through a lender, but be aware that this is usually for a slightly higher price. The more you can save up front, the better.
Lenders also have different costs, so it's important to shop around and compare the annual percentage rate (APR) shown on each loan estimate. Some of these fees can also be negotiable as lenders want your business. The greater the difference between the interest rate on which your payment is based and the APR, the more closing costs you will be charged. You should get estimates from a few different lenders.
Now that you know what to expect, it is time to prepare. Let us help you save for a home.
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