For many people, Millennials included, buying a home is a rite of passage. Though Millennials tend to be a misunderstood generation, the American dream is alive and well with them. Since many are growing their families, homeownership is top of mind.
While we completely understand the desire to own a home, below we’ll review why we believe it may not be the right time to take the plunge, unless buyers intend to stay in the same house forever.
A Brief History of Mortgage Rates Since 1980 – And Why it Matters
In 1980, when I entered adulthood and my parents bought their dream house mortgage rates peaked at 18.63%. Imagine paying almost a fifth of the purchase price every year? That is what our parents had to do. My first mortgage in 1986 was 10.5% so when my wife and I bought our current house in 1996, rates seemed a bargain at 8.5%. Making our monthly payment was still a challenge. Twenty-four years later, we just refinanced to the unbelievably low 30-year rate of 2.375%. This cuts a payment in half on the same principle. This in turn means buyers can afford to pay us twice as much. If you include inflation and all the money spent on what my wife assures me were necessary upgrades, you get close to the current inflated Zillow estimate.
Will my adult children have the same wind at their back? The answer is almost certainly “no.” Mathematically, mortgage rates cannot have the same declines over a Millennial’s lifetime as they have had over my adult life. Instead, mortgage rates are likely to increase. If mortgage rates merely rise to where they were during the last financial crisis, a previous historic low of 5.36%, then homeownership will still cost 38% more. Either the same home buyers must earn 38% more, or homeowners will have to reduce their asking price.
To add to the potential pain, what worked for baby boomers on the way up – leverage – may cut the other way. In a rising market, if a buyer puts 10% down and prices rise 10% they have “doubled their money”. The reverse happens on the way down. A mere 5% decline can wipe out the life savings when you include the transaction costs of buying and selling.
Other Factors Affecting the Housing Market
Even if mortgage rates don’t rise any time soon, there are other reasons why markets might sag. New homebuyers are excited by the idea of not “wasting money on rent.” However, now they are wasting money on interest, insurance, homeowner association fees, maintenance, and taxes. These factors are almost universally underestimated.
As I write this, coincidentally, our water line burst under our driveway instantly creating a bill of $15,000. Commercial landlords estimate about 1% of the purchase price for annual maintenance. That would be $15,000/year for a typical Los Angeles house. This is in line with our experience.
Consider How Long You’ll Be Paying Off Your Mortgage
Mortgages are designed to be paid down. But many baby boomers have failed to do so. Putting kids through college, saving for retirement, raising a family, and maintaining a home has prevented them. If Baby Boomers could not pay down their mortgages, how will Millennials do it? We were saved by rising home prices. They may not be.
When Millennials and other homebuyers realize the script has flipped, and the property is no longer a wealth generator, the market psychology could turn very quickly. We got a hint of this in 2018 when mortgage rates rose, and our clients had to reduce their asking prices and still could not sell. But COVID came, mortgage rates plummeted, and hey presto! In the fall of 2020, those same clients sold their houses above the asking price.
A Note on Buying More House than You Need
For 40 years, the more you borrowed the more you made, creating a huge incentive to buy more house than you needed. You got to live like royalty and, essentially, get paid for it! Now, housing may become more like an expensive consumer item, that gradually erodes your personal net worth. This may create an incentive to live more modestly, like in Germany and Japan. This may serve to reduce the demand for housing, and the average family’s required square footage, which over the years has risen from 850 sq/feet in the post-war era to more than 2,000 sq/ft today.
If you are going to live in the same house forever, the math of these ultra-low mortgage rates may still make sense. And it must be said, no one has a crystal ball. Prices could continue to rise. The Federal Reserve has promised to maintain interest rates at these zero bound levels for the foreseeable future. Rates can go below zero. Germany and Japan have negative interest rates. In Denmark, even mortgage rates went negative last year, so Danish borrowers got paid to borrow money to buy a house.
Indeed, real mortgage interest rates in the US may already be close to negative after taking account of tax and inflation. So even US borrowers may soon be getting paid to borrow.
So my concerns for Millennial homebuyers may never play out. However, even though the Federal Reserve hasn’t raised interest rates, mortgage rates have risen from the all-time lows they reached in September. And, if at some point, inflation finally rears its head causing mortgage rates to skyrocket, home prices could fall sharply just as they did back in the 1970s. My hope is that Millennials never pay 18.63% as my parents’ generation did. Of course, if they do, house prices will fall and be a bargain by today’s standards. Even a much smaller adjustment may be worth waiting for.
When my wife and I bought our home the housing market was dead. All buyers could see where the potential problems. House prices had been falling, and we got our house at the decade low. It is difficult to imagine now a time like that ever happening, but historically it always does.
Sometimes market timing works, and my hunch says now is not the time to buy. Of course, as my wife reminds me our house is NOT a financial asset. It is our home. And that is true. But, from my perspective, it sure helps when it is both.
Every case and need is unique so make sure you run the numbers for your situation. For a simple analysis use a calculator such as this:
For a more thorough analysis feel free to reach out to us or contact your own financial advisor.
The above should not be considered investment advice. It is for informational purposes only. Please consult with your own tax and financial professionals before acting.