Buying a Home in a Changing Economy
Changes on the horizon. It is fairly obvious that the U.S. economy is in a state of change. Whether or not this will result in a brief slowdown or a longer downturn remains to be seen, but indicators point strongly to a weakening economic outlook at the very least.
Visitors to this web site and readers of our newsletters have known our position on devoting too much of your financial resources to buying a home. For over 18 months we’ve cautioned numerous times that economic conditions have a way of changing–and assuming that a current situation lasts forever is economic nonsense. It has been dismaying to see home buyers push themselves to the end of their financial limits when securing a mortgage, assuming that their personal financial condition could do nothing but improve. Part of this problem is due to many home buyers insistence on “the best and the most” when they purchase a home as well as lenders pushing the envelope in qualifying ratios for these buyers. Buying too much home and then spending too high a percentage of income to buy that home can be a dangerous combination.
Financial common sense and responsibility are important in any economy–whether booming or in bust. Todays problems have occurred as buyers assume that the artificially expanding economy of the last few years is there to stay, or believing that it is a certainty we’ll return to the boom in a matter of weeks or months. In contrast, say some of the most bullish analysts, the best scenario for the next 6-12 months appears to be a period of slowed growth. Other analysts see the possibility of zero growth and many point toward signs of at least a brief recession (2 quarters of negative growth). Some sectors of the economy are already experiencing layoffs and cuts in overtime.
Good or bad time to buy? Does this mean that it is a terrible time to buy a home? Definitely not. What it does indicate, though, is that it is crucial to keep a firm grip on your financial situation to avoid the kinds of potential problems that can occur when an economic turnaround occurs:
- 1.House poor. By putting too much emphasis (and income) into your housing expense, you may be forced to cut other expenditures, whether it be for travel, entertainment or some more important needs, such as education expenses or retirement funding.
- 2.Financial exposure. Pushed to your financial limits, your exposure increases–the chances of not being able to meet your mortgage payment obligations increase dramatically as that payment takes a higher percentage of your income. In addition, if funds get short and you focus your payments on your mortgage, other loans and obligations (and your credit rating) can suffer.
- 3.Housing values. Economic downturns are often accompanied by, at the very least, stagnation in housing values. And, even though it sounds crazy in markets that have seen double-digit annual appreciation in recent years, occasionally housing values will decline (as they have in recent years). Worse than a situation where it is difficult to pay your mortgage is one where there is the prospect of losing a home–or trying to sell it in a distressed market.
The good news. For the astute, this can be an excellent time to buy a home, for a couple of important reasons:
- 1.Lower interest rates. Mortgage interest rates are at their lowest level in over a year, meaning lower payments and the ability to devote less of your income to your housing expense. What it does NOT mean is that you can buy more house than you need at less payment.
- 2.Less competition. As the market softens, less buyers will be in the market, meaning that your negotiating position will be enhanced–and, it is unlikely that you will have to pay thousands of dollars over the listing price in order to get the home you want. More negotiating power usually means lower prices and lower monthly payments.
How to cope. Dealing with a downturn is not that difficult if you remember to keep a couple key financial points in mind.
- 1.Maximize your down payment. Our belief is that it is NEVER wise to put less than 3-5% down on a home. Even if the economic situation does not change, your personal situation may. Trying to sell (because of job changes, transfers or family size) a home in which you have no equity means that you will have to take money out of your pocket to sell. In addition, you will need cash for down payments and closing costs on a new home. No down payment mortgages or, worse, 125% mortgages, leave you no options should you need or want to sell.
- 2.Get less than you qualify for. The historically established mortgage qualifying ratios (total payment, including principal, interest, taxes and insurance) of no more than 28% of total gross income and total debts (including mortgage and all other loan and credit card payments) of no more than 36% of total gross income are the MOST you want to qualify for. Better still is to buy a home that allows you to maintain even lower debt to income ratios, giving you some breathing room in the future.
- 3.Approach your mortgage with as much information as possible. A good start is the page devoted to mortgage hints.
Summing up. Getting a home in a changing economic environment is not all that difficult if you maintain your focus and your budget. As we’ve said many times in the past, it’s better to have a home that is a little less than “perfect” rather than not have a home at all. Remember, you can always upgrade in the future.