According to the Fed, Home Buyers Are Being Irrational

A For Sale sign in front of a two-story house surrounded by trees and a lawn.

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A key factor in landing a fair housing deal is removing our emotions from the equation.

Key points

  • The Federal Reserve says the current housing market is unsustainable.
  • Home prices have risen 27% since 2020.

According to the Federal Reserve Bank of Dallas, the housing market shows "signs of a brewing U.S. housing bubble." The Fed isn't saying the sky is about to fall, but points out a couple of troubling trends.

Troubling Trend No. 1: In an attempt to slow inflation, the Federal Reserve has slowly raised the prime rate (by raising its federal funds rate). While the prime rate does not directly impact how much interest you pay when you take out a mortgage, it does play a role in how high (or low) lenders set their rates. The higher the interest rate, the less expensive home the average buyer can reasonably afford.

Troubling Trend No. 2: Normally, as interest rates rise, home prices drop. That's not happening, at least not yet. As of March 31, the average cost of a home nationwide was a record $405,000. Home buying jumped during the pandemic, a fact that surprised everyone. And though it's slowed in some parts of the country, the market is still dangerously tight. There are far more potential buyers than there are properties for sale.  

The ‘exuberance measure’

As the Fed studies what's going on in the housing sector, it measures how hot home buyers are to jump into the market. Once the exuberance measure goes above 95%, it indicates people are irrationally excited to overpay for a house. 

The current exuberance measure stands at 115%. 

Herein lies the problem

An unexpected byproduct of the pandemic was the number of people who decided now was the perfect time to buy a house. For example, millennials -- currently the largest generation in the U.S. -- have hit the age where they want to own a piece of the American Dream. At the same time, those who now work from home are free to move out of cramped quarters in cities to suburbs where they can buy a larger home. Add to this the fact that more baby boomers are staying put instead of downsizing, and you have a recipe for housing shortages.

As a result, average home prices have risen by nearly 27% since 2020. 

The fantasy

As we watch home prices soar, it's easy to believe that price increases will never end. For the person who fears they'll miss out, it’s easy to talk themselves into the fantasy that home prices will never stop climbing, or worse yet, they will never go down. 

Simply put, the current level of growth is unsustainable. Buying a home for more than it's worth today means taking a hit when the housing market levels out. 

How to cool the exuberance 

As someone who nearly made an offer on a house more than $100,000 over my budget earlier today, I know what it feels like to want the house hunting over with. If I want to live with my husband, I have to move to another state, which means selling my current home and buying another. It's a lousy time to take on this particular challenge. And yet, I've lived long enough to know that nothing lasts forever.

Here's how I (and you, if you're buying) can cool our heels long enough to make a financially sound housing decision:

See this as a temporary trend

Like Pet Rocks, Beanie Babies, and snap bracelets, trends change. This practice of overpaying for houses and waiving inspection contingencies will not last. It would have been a mistake to pay more for a house than it's worth. In time, home prices will normalize, and I will regret making a permanent decision based on a temporary trend. 

Trust your brain

I tend to follow my heart. I cannot do that when it comes to a decision as important as taking out a mortgage. This morning, I told someone about the house we were tempted to buy. She (rightfully) read me the riot act, knowing how important it is to us to make smart financial moves. Talking it out with someone I trust is enough to remind me that I was emotionally caught up in the situation. If you fear you're about to make an emotional decision, you probably are. Talk it over with someone who knows you well enough to be honest. 

Find a new real estate agent

The agents we are working with are excellent, but that hasn't always been the case. If you're working with an agent who pushes you to "make an offer immediately" or stretch your budget to the breaking point, it's time to find a new agent. You need someone who respects your financial limits and helps you stay within budget, even while others are fighting over a house like sharks at feeding time. You deserve a representative who puts your needs above their own. 

Yep, it's a challenging time to buy a home. Still, I'm convinced there's a way to find something we like without losing our ever-lovin' minds. 

Our Research Expert