It is a complex time to be a young home buyer.
Mortgage rates are near-historic lows, which is luring many people—including first-time buyers—into the housing market. In 2020, sales of previously owned homes surged to their highest level in 14 years, and many economists forecast sales to rise again this year.
But the supply of homes is tight, and new construction can’t keep up with demand—which means that buyers often have to fork over a staggering amount to close a deal. U.S. house prices soared 12.2% in February from a year earlier, the biggest annual increase in data going back to 1991, according to the Federal Housing Finance Agency.
For millennials who are looking for a home, this means a tough calculation. Many of them have limited funds and are carrying a lot of debt. So, is it worth stretching their resources to buy a more expensive house if they can lock in a lower mortgage rate for years to come?
Or should they wait until housing prices cool down to more affordable levels—and risk having mortgage rates rise in the meantime? Already, rates recently hit their highest level since June, and many economists expect them to continue creeping upward this year.
Debating the issue are Susan Wachter, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, and
vice president for housing finance policy and the founder of the Housing Finance Policy Center at the Urban Institute.
YES: Interest rates are low and housing prices are unlikely to come down
By Laurie Goodman
Interest rates are at near-historic lows. There have been only eight months in the past 50 years when rates were lower than they are now—and those eight months were all during the pandemic.
That is why this is an ideal time for young people to stretch themselves financially to buy a home.
While home prices have increased dramatically over the past year, and might seem high by historical standards, they’re unlikely to come down, as houses are in short supply. Interest rates, meanwhile, are likely to rise.
Young people who want to become homeowners should take advantage of the situation to lock in their mortgage payments for the next 30 years, essentially inflation-proofing their housing costs. Having a stable housing situation is crucial. Landlords can raise the rent to an unaffordable level or refuse to renew the lease for any number of reasons. If young people remain renters, they can expect their housing costs to go up each year, perhaps faster than the rate of inflation, especially given the tight housing supply. Even if a mortgage payment is a stretch for young people today, they will grow into the payment, as their income is likely to rise over time.
There’s another crucial advantage to homeownership: It remains the best way to build long-term wealth. Even though many young people saw their parents go through the great financial crisis, with home values down 25% from the 2006 peak to the trough in 2012, home values are up 73% since the 2012 lows and are 29% above the previous peak, according to Urban Institute calculations based on data from mortgage-technology and data firm Black Knight. Bidding wars are erupting in many markets because of low supply.
Some argue that the current appreciation rate in home values is unsustainable. But the housing-supply shortage and production of new units that is low by historical standards suggest that values will continue to rise. And even if the rate of appreciation slackens, home buyers can still see strong returns on their investment.
New borrowers, on average, put down about 5% of the home’s cost, financing the balance with a mortgage. If the borrower puts down 5%, or $10,000, on a $200,000 home, and the home increases a modest 3% annually, the home would be worth $231,854 after five years. The five-year return on the borrower’s $10,000 investment is 316%—a figure that you’re unlikely to get with a $10,000 stock-market investment. The earlier a young person can stretch to access homeownership, the more time they will have to accrue the benefits of this leveraged investment.
Of course, homeownership isn’t the best option for everyone. There are transaction costs, in the range of about 8%—5% for buying and selling the home and 3% for various mortgage closing costs and expenses. This suggests homeownership isn’t ideal for people who intend to move within a year or two, as the transaction costs outweigh the wealth-building benefits. But geographic mobility has been declining, with millennials moving less often than their parents did at the same age.
Some may also say that we’re heading for a debt bubble—a big driver of the last housing collapse. But mortgage debt is way down right now, and other debt is nowhere near the levels it was before the 2007-09 recession.
Finally, critics bring up a potentially huge downside to buying a home: If a financial crisis hits and you get laid off, you might miss your mortgage payments and stand to lose your house. But even if you do lose your job, you’re not stuck. In most recessions, home prices don’t decline—so you will likely be able to sell your home without taking a loss and downsize to a less-expensive one.
Bottom line: If a young person interested in homeownership has the opportunity to buy a home in this low-interest-rate environment, they should do so. There is no guarantee that interest rates will stay this low for long, and the earlier homeowners start building equity, the better.
Ms. Goodman is vice president for housing-finance policy and the founder of the Housing Finance Policy Center at the Urban Institute. She can be reached at firstname.lastname@example.org.
NO: Rates are low, but don’t count on home prices continuing to rise
By Susan Wachter
Mortgage rates, under 3% for most of the year, continue to remain below levels not seen since the 1950s. Amid these low rates, Covid-19’s acceleration of the adoption of remote technology means that young home buyers have more freedom to move to areas where they can work from homes that are more affordable and offer a higher quality of life. It also means young home buyers may be inclined to financially stretch themselves to take advantage of these once-in-a-generation rates. That would be a mistake.
Homeownership is a proven wealth-building asset, and a way to avoid rent inflation, and a 30-year fixed-rate mortgage at today’s low rates is generally a safe product. And prices today are rising at a rate of 12%, the highest rate since 2006. But stretching financially and taking on the risk of not being able to pay the mortgage means young buyers are betting on housing prices continuing to rise.
Low rates and tech-driven demand are fueling the blistering rate of housing-price increases, but this past year’s appreciation rate isn’t sustainable. Future volatility cannot be ruled out if, for example, interest rates and mortgage rates rise. It is a seller’s market now due to these significant demand drivers facing historically low inventory and high construction costs, as well as a limited supply of developable land. Still, a seller’s market can shift to a buyer’s market quickly.
As the experience of a decade ago shows, housing prices can plummet—and fast. Upward price pressures can be incorporated into expectations, which make dramatic drops in price rises more likely when expectations reverse. In the 2007-09 recession, more than eight million households lost their homes to foreclosure in a systemic crisis brought on by overleveraging, according to data and analytics firm
The price bubble before the financial recession was driven by a debt bubble, giving credence to caution by new home buyers to avoid overextending their borrowing and payback capacity. This is an issue for younger buyers who have other debt, such as student loans.
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By treating housing like any other financial asset, a homeowner neglects the reality that, in an adverse scenario where they cannot repay their mortgage, they stand to lose more than an investment; they stand to lose their creditworthiness and their home. Stretching to borrow can seem like the right thing to do, to take advantage of low rates, especially when young buyers think about all the years they have to both pay down the mortgage and to increase their earnings. But buyer’s remorse can take over if and when housing prices plummet, especially if this occurs along with a recession.
In a recession, loss of jobs and housing-price declines can both make it impossible to pay back your mortgage and can wipe out your equity. The loss of a job for even one jobholder in a household can make it difficult to pay back the mortgage. A recession is likely to see more distressed sales as a result. These sales, in turn, can weigh on the housing market, causing prices to fall, making it more difficult to recover equity.
A destructive cycle
In fact, the worsening outlook can lead to negative feedback loops as price declines undermine household wealth, and the financial sector itself is exposed to mortgage losses and pulls back on lending, and both worsen the economic outlook. Younger households have more financial burdens and less current earnings and would be less likely to be able to weather this.
During the pandemic, housing prices have outperformed many investments, and in the long run, ownership is a means of building wealth. But stretching to buy a house or to buy too expensive a house may put the young homeowner in a precarious position. Ultimately, the notion of stretching one’s means to take advantage of low interest rates or other affordable lending products will continue to be a gamble with potentially devastating impacts to the young home buyer and the overall economy.
Prof. Wachter is a professor of real estate and finance at the University of Pennsylvania’s Wharton School and co-author, with Adam Levitin, of “The Great American Housing Bubble: What Went Wrong and How We Can Protect Ourselves in the Future.” She can be reached at email@example.com.
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