Jan 5, 2023 — Business Loan — Eric Giguere
If you've read the business section of any website or newspaper lately, it seems like inflation is the topic that's on the tip of everyone's tongue. You can see the impact on everything, from gas prices to soft drink prices. But if your goal is to buy a house, the impact may be more than just the price.
We'll take a look at the effect of inflation on home buying so you can feel confident in your understanding of what's happening in the market right now. Let's start from the beginning.
Inflation is the rate at which prices rise over time. For a single individual, inflation is a negative thing. It means that the money in your possession now is worth less then it was when you got it. But from a macro view, some inflation is good.
There should be inflation in any healthy economy. Prices tending to rise over time encourage people to buy goods, houses, and services now, rather than waiting for later. This means that there's plenty to do for producers. This allows them to continue hiring people, who buy goods and services of their own.
You need to keep your inflation in check. A can of soda that was $1.50 from a vending machine shouldn't suddenly become $5. Another place we tend to usually see inflation show up first is the gas pump and this tends to generate headlines as well. According to the Federal Reserve, inflation should be below 2% per year in the long-term.
Housing is affected by inflation in two ways. The price of the homes and mortgage interest rate.
Home prices are like any other item that you can purchase. This makes sense because the cost of building homes is going up. This is passed on to builders.
Homeowners of existing homes, if they're behaving as rationally as any economist would expect, However, it's worth noting that inflation isn't the only impact on home prices and that homes do tend to experience real value increases over time due to a variety of factors. Let's examine the individual home price increases. We'll be discussing some of these numbers later.
When a home appreciates, it's experiencing price increases above and beyond those that would be accounted for by inflation, thereby seeing real gains in value. There are many variables that influence the value increase:
Inflation is expected to increase, so interest rates will also rise. The goal for any investor is to earn more from the investment then they put in. To make this happen, your investment should earn less than the inflation rate.
Investors who are experiencing rapid price rises are less likely to be attracted by mortgage bonds. They offer a fixed return and are therefore not as attractive. If inflation is rising 6% within the same period, then you don't want to receive a return of only 4%. Investors will stop buying bonds and instead invest their money in stocks. Stocks offer a higher return for the same risk.
In response to this, bond yields rise with the hope of attracting investors again. An investor will buy in when they calculate that the return is greater than their expected rate of inflation. As the yields of mortgage-backed securities (MBS), increase, so do mortgage rates.
We now know the normal impact of inflation on housing prices, so let's look at what's going on in the market today.
In fact, house prices have increased at a much faster rate than inflation over the past few years because of low interest rates.
According to the most recently available Case-Shiller House Price Index data for April, home prices were up 14.9% overall on the year. Data from the Federal Housing Finance Agency puts the percentage even higher at 15.7%. There are several reasons why this is so.
First, because the inventory is so low, demand is not being met, which drives up the cost of existing inventory. Relative to the current pace of sales, the supply of existing homes available on the market is 2.6 months. For new homes sales, it is 5.1months. A market is defined as a balance between sellers and buyers at 6 months supply.
The fact that everyone knows there is a supply problem doesn't help. Some people renovate their existing homes rather than trying to put it on the market.
While the supply of new homes is greater, people still want to live in existing homes as they are historically more affordable. The gap is closing because of the low supply on the existing home sales side. The median price of a new home was $374,400 in May. In June, existing home prices reached a median value of $363,000.
In addition to low inventory, the prices of new homes are likely to be higher. There are a few reasons for this. While it is down slightly from the recent out-of this-world highs they are still very high. It's possible for construction to start much quicker than it would be possible to build the production in a sawmill. Also, wildfires have recently affected it.
Many industries have been having difficulty finding labor because of COVID-19, fears, or lack of job matching between labor force and employers. Construction has been no exception. Construction costs can rise due to higher wages, which could lead to higher home prices.
Overall inflation has suddenly risen 5.4% in the last year, according to June numbers from the Bureau of Labor Statistics. This is the highest rate of inflation since August 2008. According to the Federal Reserve it believes the inflation rate is temporary. This result is due to demand skyrocketing as we approach the end of the pandemic. The supply chain kinks have not been sorted out yet. Demand has outpaced supply.
But, if inflation was to continue at this pace, then the Fed would eventually have the need to raise the federal fund rate to try and reduce inflation. If they do this, interest rates will eventually rise in all areas of the economy. This includes mortgages.
Rates are still very low right now. Recent surveys by Freddie Mac show that 30-year fixed rates are in the high 2% area. However, no one knows for how long. Now is a great time to purchase if you are financially ready.
The Fed buys $40 billion of agency MBS each month, which means that interest rates are slightly lower. Although the Fed has indicated that there will be ample warning before any changes to current policy are made, there is still demand for mortgage bonds so rates can be lower while still attracting buyers. Rates will go up if there is no buyer to fill the gap if the Fed withdraws from the market.
While it may make sense for inflation to drive up prices in the short-term, the longer-term view shows that prices could level off or dip slightly when the Federal Reserve raises its short-term interest rate and long-term rates. Depending on where you look, some data sources seem to suggest this is already happening. Why is this?
It's easy to see why prices are so high. Sellers know that borrowers have greater buying power due to low interest rates. When they go up a little bit, that buying power goes down and eventually sellers will have to lower their expectations a bit and prices may even come down.
If you're thinking about buying in today's market, you'll want to take the following tips into account.
Lenders look at the DTI as one of the most important qualification factors. The DTI measures the monthly amount of your current installment and revolving loans compared to your gross monthly income. The better, the lower this percentage. This means that you are able to afford a higher monthly cost, which can allow you to buy a larger home. This could prove to be important in a competitive market.
Also, you don't want any credit card purchases or new accounts opened. This could increase your DTI which can cause problems during the mortgage process.
Some mortgage types may allow you to get a loan with a higher DTI. However, it's best to keep your DTI under 43% to ensure that you have the most options. Your budget will be more flexible if you can reduce your debt and keep it under control.
Also, regardless of DTI, it's generally not advised to spend up to the top end of your budget. If you do, one income shock or unexpected medical bill could put you in financial trouble. House poor is something you do not want. By being more conservative when you offer your house, you can achieve other financial goals. For example, you can create an emergency fund or have money saved for vacations.
Paying down debts ties in well to this next section because doing that will help raise your credit score. Not only do you need to have a minimum credit score in order to qualify for most loans but also the best rate, the higher the score will be.
Prior to applying, it is important that you take care of any negative credit items such as collections and charge-offs. This will increase your score.
This is a must if you want to understand them. To avoid surprises, each bureau can provide a credit report every year. These reports are available to you weekly, as an extra measure of awareness in the midst of the pandemic.
Because home prices are what they are, it is possible to not get everything you want within your budget. Find out if there are any items in your budget you aren't getting any value from and eliminate them. Only buy what you really need.
Secondly, when it comes to the house, determine the things you absolutely need, followed by the things you most want and then what you can live without. This will prevent you from getting into a bidding war and spending more than your budget.
You can obtain a conventional loan for a single-unit primary home with as little as 3 percent down. This can vary depending on the home prices in your area. Moreover, if you can put down the bigger down payment, it can really pay off to do so. Your rate will also be affected by your credit score and your down payment.
The basic principle is that the lender must give you less information to lower the risk of the loan. The other option is to buy down your interest rate by paying closing costs for discount points (prepaid interest). One point equals one percent of the loan amount. Most lenders will advertise rates linked to a point amount.
Also, you need to consider other closing costs. In addition to discount points, this can include things like title work and recording fees, appraisals, prepaid homeowners insurance premiums and escrow/impound account setup. These fees can amount to 3% - 6 percent of the purchase price.
Lenders may be willing to negotiate lower closing costs by offering a lender credit. However, this typically comes with a slightly higher interest rate. The better the savings you can make in advance,
Lenders can also charge different fees so it is worth shopping around to compare the annual percent rate (APR), on each loan estimate. Some of these fees may also be negotiable as lenders want your business. The difference between your interest rate and APR will affect the amount you are charged for closing costs. You will need to request estimates from several lenders.
Now that you're familiar with the basics, it's time for you to get started. Let's make it easier for you to save for a house.
