The America Dream of owning one’s own home is a noble one. But the ease with which many in the past decade were able to make this dream a reality, may come at the cost of those who are in the market today.
Housing had become too attainable.
Being able to put as little as 3.5% down instead of the conventional 20%, lowered the barriers significantly for first time home buyers. The logic was that prudently saving up 20% in down payment over the course of several years was not needed. However not only did it shave years off the amount of time needed to save up to buy a home, it also greatly increased the amount of home that one could buy. Just $50,000 saved up could buy a home valued at up to $1.42M, assuming that person had the income to make the monthly payments. Which is made a lot easier with dual income couples. At 20% down, the same buyer would be limited to shopping for a house up to $250,000. Thus started a mass keeping up with the Jones’s surge where buyers, especially young couples, started snapping up as much house as the banks would let them.
However 3.5% loans weren’t the end of the world. There were monthly Private Mortgage Insurance payments (PMI) effectively penalizing those who put less than 20% down. More importantly, interest rates only got as low as around 6% in the mid 2000’s, meaning the more money you could put down, the more noticeably lower the monthly payment was.
That all changed during the crash of 2008. Fed rates were cut to zero and home borrowing rates remained at historic lows for over a decade, reaching the bottom in 2021 where many were financing or refinancing into interest rates starting with a 2. What used to be a crowning achievement in one’s personal resume (becoming a homeowner), now only had a knee-high barrier to entry. A couple each making a modest $60,000 per year with only $35,000 saved up could get financed for a $1,000,000 home purchase.
Now we’re seeing the effects of that monetary policy play out. The great housing crisis, as it’s been dubbed, is in full force. Homeowners who would have otherwise been looking to upsize or downsize their home, are now stuck between a rock and a high interest rate. With 30-year fixed mortgages in the 2’s or 3’s locked in, the argument to move has become moot. This has created a virtual dam in the supply of properties on the market which has caused prices to go even higher when they normally would have been going in the opposite direction in a high interest rate environment.
The Fed could cut rates to their previous low levels which would free up the would-be-movers to buy a new house at comparable monthly payments. But then that would encourage even more buyers to flood the market and exacerbate the existing predicament we’re in. Like current government spending, it’s a short-term fix at the cost of the long term.
The best solution is unfortunately a painful one. Borrowing rates can never return to what they were in 2021. There must be a balance where a borrower should be incentivized to bring as much down payment to the table and be forced to make a decision on whether to put additional income towards paying down principal or a different investment vehicle. This “healthy” interest rate is roughly between 5% and 7%.
To return to a healthier ecosystem, as much of the cheap debt issued between 2010 and 2022 needs to be weeded out forever. The bad news is there’s little that can be done to help this process along. The only option is to sit and wait as some of these homeowners look to cash out or have extenuating circumstances forcing them to sell. What’s more important is to rid the perception that this is a momentary blip and that we will return to near zero interest rates in a few months. 2% and 3% interest rates need to be seen as an exception in time, never to be repeated again.
Robert Rixer is an Australian-born real estate entrepreneur who founded the national commercial brokerage Citypoint.com and is the author of the book Forced Appreciation: Multifamily and Commercial Real Estate for Today’s Investor.
robert@citypoint.com
(312)-983-0519
https://www.linkedin.com/in/robertrixer/
