Should you buy a home in this crazy market? Should you pay above and beyond asking price?
disclaimer – my opinion, zillow used for calculations, will edit as needed. just hoping to help people.
Hi,
For the past 2 years or so, I have been seeing a lot of question on various forums where people are wondering if they should buy a home? Most recently, I am seeing a lot of people frustrated because they are getting overbid on homes.
Please allow me to share my perspective from finance and historical value perspective. Get yourself a beer and chips, get your SO as well.
Go slow – think about it from higher though level perspective – not your immediate reactive nature as all we do **
** This are generalized thoughts, your situation may vary, your patience may be different, your need may be different, not a financial advice. **
Firstly, It is evident that majority of people look for a house at a PRICE at which they can afford the total monthly payment, inclusive of all costs (e.g. mortgage payment, insurance, HOA, taxes, …). Heck, even the banks make sure you can afford the total payment based on your total debt to income ratio.
Secondly, Changes in the appraisal process which has led to widespread overappraisal/over-valuation problems already. Many of us don’t even know how much a home really is worth. Sellers offloading their hazardous properties to new home buyers who are sold cheap mortgage rates and fear of increased rates soon.
Thirdly, we all agree that an economic disruption that could causes a marked rise in unemployment, would have a negative impact on the housing market and could be quite large one, many people may no longer be able to afford mortgage payments.
Fourthly, loan forgiveness ( I forget the program name) has/had temporarily alter the perception of credit health in the housing sector. which has recently come to an end.
————–
So we all know that it is also evident that cheaper mortgage rates draw more housing demand because total payment affordability. Let’s look at some math to understand so called cheaper interest rates but expensive housing prices vs. higher interest rates vs. cheaper housing prices.
Assume:
Buy $1M home in Austin, TX with 20% down payment.
Your cost would be broken down as
$1,000,000 price – 200,000 down payment = $800,000 loan.
2.5% interest rate your monthly mortgage (principal and interest) would be $3161.
Adding taxes @ 1.98% at $1M assessed (I know this could be lower but lets use worst case) would be $19,800 a year or $1650 a month.
Adding $75 HOA a month, along with avg. utilities cost at per month cost: Water/sewer $125, Gas $50, $125 for internet (inclusive of Netflix etc) and electric at $200.
(note I am going to keep the utilities and HOA costs constant going forward).
Your monthly payment would be $5,553.
Now assume your interest rates changes to :
Ok so far it just a dang simple calculation – I know I know.. now lets look at how you would hurt yourself overpaying for a home.
Overbidding –> Now assume:
-
you overbid your home by $100,000. Price now $1,100,000.
-
assessment also catches up to $1.1M – your new property tax is now $21, 780.
-
down payment increases by $20,000.
With some minor changes to your home insurance,
your new total monthly payment is: $6034.
This is same as paying 3.5% interest rate folks
Now lets assume, that as FEDs raise rates, the mortgage rates increases, housing cools down. Builders are building like crazy which they are and there is price reduction as seller want to take advantage of selling their houses in this nice hot market. So they actually reduce the prices.
New home prices for what was $1M is down to $900K. your interest rates are now higher to say 3.5% instead of 2.5%.
New calculation:
-
House price reduction by – $100,000.
-
assessment also reduced down to $900K – your new prop tax is now $17, 820.
-
down payment reduced by $20,000.
Your total monthly payment is now (guess what) $5,476 almost identical to 2.5% mortgage rate.
Now your difference interest paid over 10 years for 2.5% loan vs 3.5% loan is approximately $31,000 ($221,326 vs $252,304).
*Remember this, I will refer back to it later*
In other words, what I am proving to you here is that what we already know but ignore,
nearly all asset are valued at the rate at which people can afford to pay for it and this affordability is derived off of the mortgage rates, income, savings, macro factors. These factors impact all players in the housing sector the same.
** NOW HERE IS WHAT YOU NEED TO UNDERSTAND **
However, as mortgage rates increase, people’s affordability decreases, and the asset prices automatically deflate.
if you are overpaying for a house today, then you are simply pulling forward the appreciation of the home that you you would have in future to now.
In other words, your home appreciation stagnates because it has accounted for maximum someone is willing to pay until sometime in the future.
This house now, has a huge portion of your saving in it and will most likely revert to mean when it comes to appreciating – which is generally 2.5% a year. (ref- https://compoundadvisors.com/2020/homes-castles-and-price-expectations).
Take for example, home prices in the out skirts of Austin (hutto, round rock, cedar park, etc.) until 2019 had increased at best 3-4% rates a year. Stock market returns were significantly higher. You will have outliers such as certain parts of Austin near downtown for sure but generally there is a lot of land in Texas, and work from home should make things cheaper over the next 2-3+ years.
Read below Carefully and think about it :
When your home will no longer appreciates, or velocity at which it appreciated decrease, at the same pace as today, you are not building home equity any longer:
YOU ARE SIMPLY RENTING FROM THE BANK. In other words, paying 0% or some low amount of down payment is same as renting from the bank.
(does that hurt?)
FYI – Stock market which has had historical returns of 8%-9% a year over risk free interest rate or bond prices. (https://www.businessinsider.com/personal-finance/average-stock-market-return).
Ah – well why F are you talking about the stock market?
Well you see, if you take that $100,000 you save from the price (pay $900K not $1M or even $1.1M), the $20K from the down payment, and $100 a month from property taxes.
And save that all in stock market at just measly 4% ROI per year. Then over the 10 years you would make over $61,000 in gains along with have $193K total.
(I am using stock market is b/c I am assuming most of us would invest there, you can subtract other assets you see fit. Calculator I used – https://smartasset.com/investing/investment-calculator#ctiwOwLtDA)
Now take the overpayment from interest you paid (2.5% vs. 3.5%) and subtract that out of the gains you had above in stock market – guess what – you still come ahead by ~$30K.
Even at just 2% in ROI per year in the stocks or somewhere else you would break even on this 2.5% vs. 3.5% differential.
Now lets talk about all these funds buying up all these homes.
Ah guess what, they are and they have been buying them for years and years. They will do so regardless of the interest rates. They bought them at 12-8-7-6%… all the way down to today’s.
Either you rent from them without a huge down payment or rent from the bank with a huge down payment but you overpay by a significant amount. ( i am not saying do not borrow just saying do not overpay b/c thats same as paying no down payment).
However, these investors too have to worry about being able to breakeven and showing return on equity. They also have two other forces that keep them in check such as macro economics and: Namely – the builders and suppliers.
You see builders job is to keep building, regardless of interest rates, or if funds or REITs, or banks buying vs not buying.
Their job is to build homes, increase share prices or get fired.
Ah and what about the suppliers – well folks – guess what their job is to keep supplying regardless of the factors. Builders don’t want to build because supplies are too low, don’t worry they will increase supply, builders cant pay now, don’t worry pay later and so on.
Yes both of the latter ones will adjust their building and supplying based on economic factors and so would all of us including hedge funds, banks, investors. So macro factors impact everyone the same.
Think about this:
you buy or build because you hope that someone will buy it for higher prices than you from you. you sell because you think someone will sell it cheaper than you to you.
So do not over pay, do the math, take the 360 degree view of your finances, your future, and NOT Only the interest rates. Be patient. my message is to not dissuade from buying a home but to show you that using math you will see that over paying is same as paying higher interest rates.
Everything will revert to the mean, we will come back to equilibrium. in 2008-2009 we had something similar and we paid for it for nearly 9-10 years.
Let me know if you have any questions. HTH
Discover more from Today Headline
Subscribe to get the latest posts to your email.