For most folks, buying a home is the most significant financial decision they will make in their lifetime. It's simultaneously exciting and terrifying and can directly impact other aspects of life.
Unfortunately, home affordability has become a runaway train in recent years. A combination of limited supply and soaring mortgage rates have pushed monthly payments to the limits of most budgets.
Maintaining a level head is essential, as well as not letting emotions tempt you into doing something you might regret later. You can't control the housing market, but this is how you can give yourself the best chance to come out ahead.
Creating a housing market monster
Today, homes are much less affordable, and the seeds were planted during the pandemic. The Federal Open Market Committee (FOMC), which sets the primary interest rate for the U.S. economy (the federal funds rate), slashed interest rates to zero during COVID-19. The country faced unprecedented economic turmoil, and the Fed pulled out all the stops to keep the economy healthy.
This made it virtually free to borrow money, and banks used that to offer remarkably low mortgage rates to borrowers who bought or refinanced their homes from 2020 to 2022, as shown below:
Effective federal funds rate, data by YCharts.
But inflation surged as an unintended consequence of this monetary policy. So the Fed countered this by quickly hiking its interest rates back up to slam the brakes on an economy that had grown too hot for its own good. Interest rates plummeted and then rocketed back up.
A lot of people jumped on these low mortgage rates a few years back. According to Redfin, more than 80% of homeowners have mortgage rates below 5%, and 60% are below 4%. It only makes sense to shed a low-rate mortgage to take on a higher one if you need to move.
So all these low-rate-mortgage homeowners are sitting on the sidelines, which is tanking the number of homes for sale -- currently near their lowest level in years:
US existing-home inventory, data by YCharts.
Since fewer homes are on the market, buyers are fighting over inventory and supporting higher prices. Combine these bidding wars with higher mortgage rates and -- poof -- you have the current affordability crisis.
US median price for existing single-family homes, data by YCharts.
Today, the typical home sells at an all-time high price, and buyers borrow at the highest rates in decades.
What you can do about it
Unfortunately, you can't do anything about what homes sell for or what interest rates do. Common sense says this bottleneck will ease over time, but nobody can predict when. However, you can control your actions to ensure you don't make a huge financial mistake. Here are three ways to do it:
1. Bite off only what you can chew
It's easy to get carried away in a bidding war. Numbers have less gravity on a computer screen, so what's another $30,000 to $50,000 to get the house of your dreams? But every $10,000 will add roughly $70 to your monthly payment on a 30-year loan at today's rates.
Make sure to stick to your budget. For example, a common rule is to keep your monthly mortgage payment at 28% or less of your gross monthly income.
2. Wait it out
Feel free to pump the brakes on the home-buying process if you're still determining where you'll be over the long term. Renting currently offers a better bang for your buck in many markets across America, so don't force yourself into homeownership.
The last thing you need is to buy a house, have the market cool down, and be forced to sell at a loss to move for that new job or whatever else.
3. Stay flexible
In the same way, consider the pros and cons of your market. The housing market is diverse, and while one city or market is scorching hot, another could offer great deals. Consider different states, cities versus suburbs, and other choices that could stretch your dollars further.
Above all, please don't stress. The market cycles up and down, and housing will likely become more affordable at some point. Remember that your situation is unique to you, and you can use these tips to find a solution that makes the most sense for you.
