The growing cost of the American Dream is clouding buyers’ visions of prosperity and stability, and long-term decisions today could mean trouble down the road.
What’s the catch? Record-high home prices, rising interest rates, and ongoing costs of ownership loom well after loan closing. Anyone looking to move this summer is wise to seek guidance from people focused on individuals’ best interests.
“Most (buyers) are quite apprehensive at everything that’s going on. Prices seem to be changing on an almost weekly basis. There’s this persistent scarcity of inventory,” says Louis Guillama, vice president of real estate operations at Coastal Credit Union. “It really requires you to just go at everything at a moment’s notice and it doesn’t allow you a great deal of time to do some research on a pretty substantial offer.”
How much is too much?
Purchases start at price tags, and the median mortgage payment is rising. According to the Mortgage Bankers Association Purchase Application Payment Index (PAPI), it increased 8.8% from March to April 2022 and a cumulative 23.7% since January. Incomes are lagging, and consumers are stuck between swelling rents and scarce homes at ballooning prices. Some are committing significant up-front money to compete.
“If you get in a bidding war, take a deep breath and sit deep in your seat if you’re going above list price,” urges Allegacy Federal Credit Union Mortgage Loan Officer Bob Church, a 34-year lending veteran only recently seeing buyers risk thousands in due diligence fees, earnest money, and contractual promises to pay any difference above appraisals. “You have to be realistic about it. If you’re already $30,000 underwater, how long are you going to be in the house to recoup that? It takes years to pay down that amount of principal.”
Interest rate and down payment factor into monthly progress. On a 30-year mortgage for a $250,000 home in 2019, a typical buyer with 20% down would pay $1,178 monthly and $141,556 in total interest based on a 3.94% average rate. At 5.32% today, that buyer pays $166 more each month and $200,764 in interest over the life of the loan. Then there are closing costs and prepaid taxes averaging $2,970 in North Carolina.
What can a buyer do? Dig deeper for a comfortable fit of home characteristics, value, and price, ideally with a down payment to reduce the loan total.
“Try to aim a little lower,” Guillama suggests, “because undoubtedly you’re going to pay a lot more than the asking price for a piece of real estate today. You want to shop at a lower price point to give yourself enough margin to still qualify at the new contract price.”
Are there tradeoffs?
A heftier loan drives up the loan-to-value ratio (LTV), interest rate, and some fees—particularly for individuals with lower credit ratings. Payments on that $250,000 home could climb out of reach if LTV exceeds 80% and triggers add-on payments for private mortgage insurance (PMI).
“We need to look at whether it’s advisable to have PMI or not,” says Church. “If they can make more on that 20% in an investment and they have good credit, it’s likely they’ll do better by paying for PMI.”
Coastal is among credit unions offering up to 100% financing with no PMI. Elsewhere, Guillama suggests buyers ask loan officers to price the PMI equivalent into the rate for increased tax advantage through deductible interest.
Higher home values since 2019 have padded sellers’ pockets for new buys, but nearly every home costs more now. Careful exchange of equity, especially for a home near the budget limit, anticipates a potential market dip. A sharp drop or early move could drain equity, sacrificing net worth and a backup funding source.
“Values are going to drop, but inevitably, they’ll come back up,” Church assures. “You’ve got to know when it’s right for you and whether you can wait out the possible decrease in value.”
First-time and government-guaranteed loan programs can minimize down payment pressure and reduce or eliminate PMI for new buyers or those with little to no upfront money. Those changing homes can preserve equity by moving to similar or less expensive homes and markets. For all, smart buying balances down payment, available equity, and PMI expense for the right home without straining the budget.
What is the cost of ownership?
Buyers beware: Even new homes at premium pricing are no shelter from recurring expenses. An eye on ongoing costs supports realistic budgeting to shield against surprises, and inspections shed light on issues that could linger.
“A lot of buyers are actually waiving inspections, not ordering surveys, and not doing septic inspections. They feel obligated to go through with a transaction no matter what,” says Guillama. “If you forego inspections, you run the risk of inheriting all those problems and have no one to blame but yourself and have no recourse. They’re your problems once you close.”
Experts like the Federal Housing Administration (FHA) say annual home expenses of up to 30% of income are “affordable.” Yet 45% of homeowners surveyed by Clever Real Estate earlier this year are spending more. Nearly one in three commits more than 40% of income to their homes.
Why? Time under quarantine prompted many to upgrade their spaces, relocate, or right-size. Home values jumped and pulled up related costs like taxes and insurance, maintenance, and utilities—and those continue to rise. Added floorspace, new surroundings, and social pressure can create an urge to fill rooms or change styles.
“The first thing I ask a member is what their goals are, because not everybody’s goals are the same,” Church assures. “I want to know what’s important to them. I want to make sure I help them achieve not just their short-term goals but long-term and find out where they are in life, because life changes.”
Like the structures themselves, homebuying is more than curb appeal and sticker price. By taking a holistic look at mortgage factors and all ongoing housing costs, buyers can find houses they can comfortably call home for years to come.
“It’s important to partner with a trustworthy agent that’s looking out for your best interests,” Guillama advises. “Continue focusing on your ultimate goal of homeownership, stay within your budget, and just make the best possible decision you can. It’s going to pay off.”