With house hunting season upon us, Americans should consider how several economic factors come into play
As the housing market searches for its bottom, the summer home buying season marks a perfect time to consider whether this is the right time to buy a house. As the economy evolves in this time of uncertainty, factors can shift to make home buying more or less attractive. What considerations matter more than others?
But before getting to that, let's get a few caveats out of the way. This analysis is meant to apply to those who are thinking about buying a home to live in for an extended period. The housing market won't roar like it did the previous decade, so buying a home to flip isn't advisable and whether to purchase for investment purposes is a different question. Some of the factors discussed below will also vary widely from location to location, so broad U.S. trends will be considered.
Why start with interest rates? They may be the most important factor to consider at this time. A number of economic forces threaten to push up interest rates in the days, months, and years to come.
Looking at interest rates alone, now is a very good time to buy.
As mortgage interest rates rise, borrowers' purchasing power falls. For example, if you can afford to pay $1,265 per month, then at 4.5%, you can buy a home for $250,000. But if rates jump 200 basis points to 6.5%, then you can only afford a $200,000 home. Put another way, even if home prices had declined 20% as rates rose, you would have to settle for a similar home at a lower price.
Interest rates are currently very low, as the chart to the right shows. Average rates were at 4.51% in the last week of June. That's not far off the low hit during the recession. Yet rates have been much, much higher in prior years. At this point, the prospect that rates could fall much farther isn't very likely.
So looking at interest rates alone, now is a very good time to buy. In the future there are several factors that could drive interest rates up.
The Federal Reserve
As the U.S. economy recovers, the Federal Reserve will begin withdrawing its historic monetary stimulus. This will affect interest rates in a few ways. The Fed will eventually raise some benchmark rates, which may push up mortgage rates. Separately, its recent asset purchase program helped to keep longer-term interest rates low, but this program ends in June, and we're already seeing rates begin to rise as a result. The Fed also has a large portfolio of mortgage securities to sell off in the future, which will put upward pressure on rates.
As the debt ceiling fight rages on, the market grows wary. If it begins demanding a higher yield for U.S. Treasuries due to the associated political risk, then this could drive up all interest rates in the U.S. As housing finance reform ramps up over the next year or two, we'll also begin to see less government influence in the mortgage market. That, in turn, will likely lead to higher interest rates, since the private sector will demand a higher risk premium.
Finally, inflation has already begun to rise and some analysts believe it will continue to do so. As it does, interest rates will rise, since lenders will want to ensure that the loans they sell don't quickly lose their value as dollars become worth less.
Knowing how dramatic an effect these factors will have on rates is difficult. But the odds are good that in the near- to medium-term, interest rates will begin to rise.
If you think that future interest rates are hard gauge, then you'll be really frustrated by home prices. The housing market is officially in double dip territory, as national prices have fallen below their recession lows. The home buyer credit only created a false bottom for the market. When it was removed, prices began to decline again. Just how far will prices fall?
The Path of Prices
At this point, the price decline is relatively slow, and banks have been working hard to keep prices from plummeting. They're slowly releasing distressed properties into the market so that consumers aren't faced with a huge glut of property listings to choose from, which would cause a quicker decline in prices. But they can't hold prices up in the long-term. Instead, their actions will just cause the market to take longer to hit its bottom.
Price movements are varying widely by location. Nationally, analysts think prices will probably still decline somewhere between 5% and 25%. In some areas the drop will greater, while in other locations prices have already begun rising again.
Worry More About Interest Rates
Attempting to time a home purchase with the bottom of home prices is a dangerous game. As explained earlier, interest rates are expected to rise over the next few years. As they do, purchasing power will decline. A recently bought home's price falling by 10% could turn out to be better a better outcome than waiting to buy if interest rates rise 2% or more over the ensuing period.
When the market does hit the bottom, it isn't likely to rally.
Yet when the market does hit the bottom, it isn't likely to rally. The sort of home price gains we saw during the bubble were not normal. In most cases, home prices follow inflation, so the real annual return on a home is pretty small. When home prices do hit the bottom, you won't have to get in quick, as they aren't going to suddenly jump.