Are Home Prices Too High?
ERIC BEISE | REALTOR
In the last five years alone the average sale price for a home in the Twin Cities has risen from $215,000 to $305,000. This is a staggering 42% increase! Naturally people are beginning to ask if prices are approaching a bubble again. Is it even smart to consider buying a home in a market like this?
Let’s consider a hypothetical purchase of a home costing $350,000. With 20% down, the principal and interest payment would be $1,165 per month, assuming a 2.9% interest rate and a 30 year fixed mortgage.
If we go back five years, the average mortgage interest rate was 3.9%. That interest rate would make the payment for the same house $1,321. In other words, you would have needed to pay almost $200 more per month for the same exact house! Clearly the listed price of a home isn’t the only factor to consider.
You could actually buy a $400,000 house at 2.9% for roughly the same monthly payment as a $350,000 house at 3.9%. This is how big of a difference interest rates make. A 1% swing can make a $50,000 difference in value.
The point is that most people don’t buy their houses with cash. Most people finance their home and are primarily concerned about the monthly payment they are paying, rather than the current market value of their property. It isn’t an apples to apples comparison to look at the value of a home today compared to a time when the interest rates were quite different.
Things get really interesting when we take into consideration the idea of selling a home purchased as little as two years ago, selling for a profit, and being able to lower your monthly payment due to interest rate changes over that time! You get money in your pocket and a lower ongoing monthly payment!
What does this mean moving forward? The truth is that we don’t exactly know. The government has indicated they will likely keep short-term interest rates near zero for approximately the next 3 years, or even longer. While mortgage interest rates don’t perfectly correlate with this, it does help keep a downward pressure on rates in general.
There are some lenders currently offering rates at or under 2%! It is a crazy time indeed. There are a few places in Europe where you can obtain a mortgage at -0.5%. Yes, NEGATIVE interest rates on a mortgage. The bank is literally paying you to borrow money. Just try and wrap your head around that.
Top economists are all over the map in regards to if something like this will ever happen in the United States. My point is not to argue that rates are necessarily going to be lower moving forward, but to say that it is certainly possible. If this type of rate compression occurs, home values would almost certainly skyrocket accordingly.
What does this all mean for you? First of all, when considering the purchase of a home that you may live in for many decades, it is far more important to ensure you can afford the monthly payment than anything else. You shouldn’t be too concerned about whether the market will temporarily move up or down as it won’t impact your life in any meaningful capacity. However, if your housing expenses make up too high a percentage of your income it could jeopardize your financial security in a number of ways. Make your decision based on what is known rather than what you don’t know.
Second, we know that interest rates right now are historically low. This means it is a fantastic opportunity to borrow money for the long term, regardless of which way rates move in the next few years. If rates continue to fall, your home value will only increase and you can always refinance. If rates eventually go back up, you will be glad you locked in a lower rate while you could.
Finally, it is important to remember that many of the factors that led to the collapse of real estate values back in 2007-2009 are significantly different now. Bank and lending regulations have changed to better protect consumers and institutions. Although there could be some foreclosures as an aftermath of the COVID crisis (I doubt it, ask me more on this), there are still far more people with strong balance sheets at this time who will swoop in to prop up demand.
For all these reasons, it seems unlikely we are currently facing any kind of bubble in the real estate market. Rather, low interest rates have just significantly increased the amount of home that someone can buy for the same monthly payment. If rates drop more, as they have in most of the developed world, prices could actually continue to increase rather significantly. We can’t predict the future, but we are ready and willing to help you take action and find your dream home or investment property today!
Keep up with Wits
More from the Wits Blog:
10 Reasons Why You Should Have Your OWN Realtor When Buying New Construction
With inventory levels of existing homes extremely low, many are flocking to new construction and assume it’s like shopping at Target. At Target, you walk in, pick what you want, and proceed to checkout. While there are some very clear benefits to buying new (Minnesota’s 10 year builder warranty, to name just one), much is…
7 Ways To (Legally) Avoid Paying Capital Gains Tax
Eric Beise | Realtor If you have held rental real estate for the past few years, you likely have seen your properties significantlyincrease in value. This is a fantastic place to be! For various reasons though, you may now be looking to cashout, upgrade, or get out ahead of some potential future increases in tax…