It’s no news that U.S. real estate is expensive — the sharp increase in home prices over the last few years has priced many people out of the market, particularly first-time buyers. In March 2020, the Federal Reserve took decisive action by reducing the federal funds rate to 0% and purchased more than $700 billion worth of government and mortgage-related bonds in response to the economic challenges posed by the coronavirus outbreak. This emergency strategy, aimed at providing economic stimulus, inadvertently led to significant inflation and a surge in home prices.
What caused this sudden jump?
As a result of monetary policy set by the Fed, the lowest historical average rate for 30-year fixed-rate mortgages was recorded as 2.65% back in January 2021, according to Freddie Mac. Home buyers were quick to lock in the low mortgage rates, and an unprecedented demand for real estate created a shortage of available homes in the market, one that many builders could not meet.
While many other factors increased home prices from 2020-22, possibly the most significant contributors were real estate investors, who accounted for a quarter of residential home sales in 2021, a more than 100% increase since 2015, according to the Washington Post. This increase in investor properties skyrocketed rent nationwide and further contributed to inflation, which peaked at 9.1% in June 2022.
Median home prices in the U.S. increased by 31.8% over the past five years. Most notably, an increase of 48.6% from Q2-20 to Q4-22, consisting of the following six quarters after the Federal Reserve cut interest rates to 0%.
The response to inflation:
Attempting to combat high inflation, the Fed began raising interest rates in March 2022, slowing down the economy and decreasing consumer spending. The Fed raised rates 10 additional times, putting the federal funds rate at 5.25% to 5.5%. This series of rate hikes was successful at taming inflation, as the consumer price index decreased from its high of 9.1% in June 2022 to 3.2% for the 12-month period ending in July.
Despite the desired outcome of lower inflation, these rate increases have shot up mortgage rates dramatically, reaching a now-21-year high, and sending the 30-year fixed-rate mortgage average rate to a peak of 7.23% in August, according to data released by Freddie Mac.
Thirty-year fixed mortgage rates over the past 21 years, highlighting the dramatic rise since rate increases began in March 2022.
The downside:
Not only do higher interest rates hurt existing home buyers who may feel stuck in their place of residence — as they do not want to lose out on their existing rate — but they also hurt new home buyers who are now burdened with high real estate prices paired with high mortgage rates, pricing most first time home buyers out of the market.
For perspective, the same $300,000 house, assuming a 20% down payment, would have had an anticipated $967 monthly payment in January 2021 but a $1,611 monthly payment in August 2023. These figures exclusively factor in higher mortgage rates and do not account for the anticipated significant increase in property values, which ups the monthly payment even further.
Home-buying strategies:
While it may seem that buying a house in the current U.S. real estate market will never be attainable, hope is assured. After The Breeze analyzed information provided by real estate agents, investors and first-time homeowners representing a variety of incomes and socioeconomic backgrounds, several consistent trends arose, allowing new home buyers an opportunity to close on a house despite minimal savings.
Putting less than 20% down: While many believe that putting a 20% down payment on a house is necessary, many lenders will accept as little as 3% down, assuming you have well-established credit and a high score. While this strategy will increase your monthly mortgage payment and require you to pay a bit extra every month with private mortgage insurance until you reach 20% equity on the property, it allows many home buyers to purchase with as little as a few thousand dollars down.
Having roommates: Although this may seem obvious, mortgages are typically cheaper than rent when divided by room, as no property manager is taking their cut. So buying a house and renting spare bedrooms to friends can be a win-win, as it can often be cheaper for all parties and lower your monthly mortgage payment while still allowing you to build equity.
Buying a fixer-upper: While often time- and labor-intensive, experts suggest that buying a house that needs renovations can be a quick way to build equity and profit from your time. Homes that need work will not only be at a much lower list price but are less competitive to buy and provide the opportunity to customize it to your liking. No experience working on houses or the cash to hire it out? Many buyers opt for a home renovation loan, which can fund this process without tapping into their savings.
Studying the market: Opportunities are everywhere — adequate due diligence such as analyzing the local market, evaluating comps, hiring the right agent or representing yourself to save money, negotiating home prices and closing costs, buying during off-peak seasons and shopping around for rates from different lenders can provide significant long-term savings. The patient and well-researched buyers will receive the highest benefits.
Refinancing:
If you took out a mortgage with a high rate, you can always refinance your mortgage later on, which might be a good move if interest rates decrease. Once you lock in a new rate that you're content with, you can keep it until your home loan is fully paid off or refinance again later; securing a lower rate could lead to significant savings in the long run and decrease your monthly payment.
You can also consider changing the loan term, whether switching from a variable to a fixed rate, or opting for a cash-out refinance, pulling out a portion of the home's equity to renovate and increase its value, or simply saving or spending the money elsewhere.
If your financial situation improves due to a higher income or a better credit score, you may receive more favorable terms — refinancing could even help eliminate private mortgage insurance if your home's value has risen. Nonetheless, it's essential to consider all costs associated with a refinance and consult a licensed real estate agent, accountant or financial advisor to make a well-informed decision that fits your unique circumstances.
The bottom line:
Interest rates are still rising, and historically high mortgage rates paired with steep home prices have made it difficult for prospective buyers to afford their first property. However, strategies such as putting a minimal amount down, purchasing a home needing renovations, renting out spare bedrooms and conducting deep research on the local market can make building equity in real estate more attainable.
While it’s uncertain when interest rates will fall again, home buyers can rest assured that they can refinance their home at any point, allowing for benefits that can lead to lower monthly payments or more flexible financing options.