What are we seeing right now in the housing market and why?
Mellody: The housing market continues to be incredibly hot. Home prices continue to break records in numerous markets, such as Seattle and Denver, and talk of bidding wars has returned to many water coolers. This has caused many to wonder if we are entering another housing market bubble. This morning, i am here to tell you i don’t think we are in for that, for a couple of reasons.
First, the drivers of the housing market in 2008 and now are very different. The last time around, we were in a speculative bubble, and people believed that home prices would just keep rising. That is not true today. Home prices are breaking records today due to supply and demand, not speculation.
Secondly, the 2008 bubble was built on a foundation of loans that people could not afford. Between 2008 and now, regulators have put rules in place to prevent the type of irresponsible lending that led to the bubble and hurt some many families financially.
Finally, we are seeing signs that the housing market is taking time to catch its breath. Homebuilder sentiment declined slightly this month, falling 1 point to 59. At the same time, existing home sales, which came out last week were up 1.1%. What this tells us is that while the market remains very strong, it isn’t a runaway train. It just isn’t a bubble.
What is fueling this strong market?
There are numerous factors driving this hot market: low housing inventory, record low mortgage interest rates, new household formation and steady wage growth. First, inventory. Right now there is a large price gap between starter homes and higher-end homes, and few homes in the middle. In addition, many of those homes that would fill in the gap are still underwater, and their owners do now want to sell at a loss. This has meant that the homes that fall in between receive a premium, which has kept many markets high.
Second, the average mortgage rate is down a full point since this time last year, and that means savings. Over the course of a 30-year mortgage on a $250,000 house, this lower rate will translate into $50,000 in savings. Rates are low because they are benchmarked to the 10 year Treasury yield, and uncertainty around the world – Brexit in particular – has driven the yield on treasuries goes down.
And these low mortgage rates are helping fuel a hot housing market. And it is not just interest rates that are bringing more buyers to the market. There was already pent-up demand. Many families put off buying a home in the wake of the economic crash, and now they are jumping back in. After all, couples can only live with their parents and put off a new house and children for so long. Together, these factors continue to bring people into the market.
Finally, the third factor driving a strong housing market is wage growth. America workers are finally getting their first meaningful salary bump in some time. The June jobs report showed nominal year-over-year wage growth of 2.6 percent. And these salary increases mean that people can afford to look for a little more house.
So is now a good time to buy a home? If so, what should we be thinking about?
Home-buying is not something that is dependent on the market. Buying a house comes after your finances are in order. Before looking for houses, you should build an emergency fund. You should be contributing to your retirement. And you should commit to not spend more than 35% of your income on housing costs, be it rent or mortgage, maintenance, insurances and taxes.
The big rule of thumb to keep in mind is that you should first do no harm to your finances. Once you have done that, consider the price-to-rent ratio. This ratio compares the costs of owning and renting, and is calculated by dividing the average list price by the average yearly rent price. In general, a price-to-rent ratio under 15 means it is better to buy, and over it is better to rent.
If you have thought through all of these things, then you can consider the state of the market. Right now, while interest rates are low, prices across the country are high, so you will have to balance those when making your decision. And remember, getting a mortgage is more difficult than it used to be. Banks are now required to make sure homebuyers can afford a mortgage, and are not allowed to give you a mortgage if your debt-to-income ratio exceeds 43% of a homebuyer’s income.
Will we continue to see a strong housing market going forward?
I do think that this will continue. It takes time for building to add more housing inventory, wage growth bodes well for the housing sector, and interest rates mean that borrowing is cheap. All of this is a recipe for a strong housing market.
Mellody is President of Ariel investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News.
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