As the economy recovers and business returns to normal, the real estate market is close to follow. It seems as if every month, there is some new real estate market record being set. As of May 2021, Zillow’s housing market report shows a 13.2% increase in the home value index over the past year. Real estate investors in the US are ecstatic, but for many Americans, this news is more than troublesome. With an average GDP growth rate of less than 2%, many potential home buyers are having more and more trouble finding affordable properties. While the rapid home price increases serve to worsen the already present issue, there are many things U.S. home buyers can do to make buying a home easier.
Why are home prices increasing so much?
Other than the housing crisis in 2008 and the most recent economic downturn caused by the coronavirus pandemic, home prices have steadily increased for the past several decades. In May, home prices were at an all-time high and it left many people wondering why. Whenever housing bubbles pop, the world is shaken. This is because home prices are one of the most stable assets and many people feel comfortable investing their life savings into owning a home. Consequently, many people like to invest in housing because of the low risk. Home prices are a function of supply and demand. As the economy recovers and people look to the low-risk investment of property, the demand for homes surge. Since supply is limited, demand increases cause home prices to rise. During the past year, there has been a 31.1% decrease in the for-sale inventory of homes, and local real estate markets all over the U.S. are now seller’s markets. This means that if you’re looking to buy a good home, you’ll likely have to compete with other buyers. In many cases, you will have to pay more than the listing price of the home.
How much can you afford?
Home prices are increasing and with the recovery from the coronavirus pandemic, this is even more true. However, many home buyers are discouraged by the extremely large purchase price of a property. After all, how many home buyers can afford to pay upwards of $300,000 on the spot for the average U.S. home. It’s also difficult to imagine that a mortgage would make things much better. For a 20% down payment on a home, you’re still shelling out tens of thousands of dollars up-front before making any mortgage payments.
Fortunately, many potential home buyers are surprised by how much they can afford in 2021. By first checking your debt-to-income (DTI) ratio and keeping it to the recommended 36%, you can find your maximum mortgage amount given your level of income. Once home buyers see their maximum mortgage, buying a home seems much less daunting. Mortgages let you spread out the cost of owning a home over several years. Using part of your monthly income to pay off a mortgage lets you invest long-term in a home and it’s how most Americans work towards homeownership. If you’re worried about the down payment, then you’re not alone, but even the down payment can be reduced to accommodate any financial circumstances. For example, you can get a minimum down payment of as low as 3% with a government-insured mortgage if your mortgage is within the Federal Housing Finance Association’s (FHFA) limits. With a VA loan, you can even get a mortgage with no minimum down payment. Even if you think a home is out of reach, government programs and current mortgage rates make it worth looking into.
What affects the amount you can afford?
While mortgages and mortgage lenders are an essential part of real estate markets that gives you access to the ever-increasing prices of modern homes, lenders are profit-seeking. Lenders need some assurance that you will be able to make payments on your mortgage and that you won’t default. You’ll often hear the term “maximum mortgage amount”. This refers to the maximum principal loan amount lenders can give out. In some cases, this term refers to the hard limits that the FHFA puts on mortgages to be insured by them and in others, it’s the maximum amount that you are eligible for. The maximum mortgage amount that lenders are willing to offer to individual home buyers depends on many factors. Lenders check anything related to your credit and financial history to ensure that you are a low-risk borrower. These factors can include:
- Credit Score: Not only does your credit score determine your eligibility for many different types of mortgage programs, but lenders may also use your credit score to adjust both your interest rate and how large of a loan you can get. They will take a full look at your credit and financial history. After submitting a mortgage application, lenders will submit a hard credit inquiry to get all your credit information, which will temporarily lower your credit score.
- Down Payment: A larger down payment shows that you have the financial means to support a mortgage. Lenders are more confident with borrowers who have significantly saved for their mortgage and are willing to invest a large sum of money up-front. With a larger down payment, you can directly increase the value of the home you can purchase because you are paying for more of the home price yourself. Lenders may also be willing to loan you more money after showing your financial commitment with a down payment.
- Debt-to-Income (DTI) Ratio: Your DTI shows how much of your monthly income you will be using to finance any form of debt. Lenders will look at your DTI ratio after incorporating your monthly mortgage payments. Typically, lenders look for a DTI of at most 36%, which means that you may only use 36% of your gross monthly income to make debt payments. A lower DTI may get you a lower interest rate and if you don’t have pre-existing debt, lenders will be more open to larger mortgages.
Government Mortgage Programs
According to FRED, delinquency rates on single-family residential mortgages are relatively low, but the number of mortgages has increased. Even with home prices increasing, it seems as if home buyers are still finding ways to buy homes. This is in large part due to government mortgage programs. While Fannie Mae and Freddie Mac provide general mortgage loans to first-time home buyers among others, many other government mortgage programs have made buying a home considerably more affordable.
The three main agencies are the Federal Housing Administration (FHA), the United States Department of Agriculture (USDA), and the United States Department of Veterans Affairs (VA). These agencies provide mortgages with down payment assistance, lower down payments, lower requirements, and still give home buyers low mortgage rates. Affordable housing programs have, to some effect, counteracted the growing home prices in the US.
Many state-specific programs provide down payment assistance, lower eligibility requirements, and other ways to make mortgages cheaper. Oftentimes, statewide programs will be in conjunction with federal programs that help home buyers even further. For expensive states like California or New York, these programs are necessary to allow local residents to afford housing. As home prices increase, government mortgage programs become a more essential part of the real estate market.
The Bottom Line
The fact of the matter is that home prices will continue to rise and as the economy recovers, they’ll increase even faster. Except for housing crises, real estate prices have been steadily increasing for decades and there don’t seem to be any real estate crashes soon. Luckily, home prices may be increasing, but that doesn’t mean getting a home is impossible. By verifying how much you can afford, keeping track of your financials, and using government mortgage programs, you can get access to mortgage amounts much larger than your expectations. Real estate will always be an expensive endeavor, but by preparing for a mortgage and getting a good deal, you can ensure that it isn’t unachievable.