RENT VS BUY in 2023…Is housing still affordable? 2021 was a crazy year for real estate! Home values in Frederick County increased almost 20% year over year! We haven’t seen that kind of escalation since the mid-2000’s. Values rose at a lesser rate in 2022, but continued to accelerate. As we watch values rise, many are asking about housing affordability in 2023.
Are you wondering if 2023 is a good year to buy, after all? Usually, the answer is based many considerations, including economics, and on your personal finances, goals, and situation. Answering the question is not a simple yes or no. But we get it, it’s an important question for first-time buyers.
First, let’s talk about math…affordability. What exactly does the term “Affordability” mean?
The National Association of Home Builders (NAHB) and Wells Fargo have been calculating the Housing Opportunity Index (HOI) for more than 30 years. They release quarterly surveys about two things: income and housing costs. The survey now covers 247 metropolitan areas across the U.S. as well as the national averages.
According to the latest HOI survey released in early 2023, housing affordability has changed a little bit since last year. Covid-19 and the many shutdowns have had an impact on just about every area of our lives, so of course housing has been affected.
Supply chain disruptions, the cost of lumber, and the lack of skilled workers has severely affected new home construction, which has affected the overall price of housing.
In all, 38.1 %of new and existing homes sold between the beginning of October and end of December were affordable to families earning an adjusted U.S. median income of $90,000 (previously $79,000). This is down from the 56.6 % of homes sold in the last quarter of 2021 that were affordable to median-income earners.
This means that 38.1% of Americans can afford to buy a median-priced home. There is a median home price…but it really doesn’t matter. Local prices are what matters to your ability to purchase a home. More on that below.
Affordability has decreased by 16% since last year in most metropolitan areas, mostly due to increasing home values AND increasing interest rates. Interest rates greatly affect affordability. Between mid-2022 and January 2023, interest rates doubled.
New homes have seen the highest price increases. NAHB sites the shortage and rising costs of lumber, and the shortage of skilled workers as the two issues most affecting the cost of building. Lumber availability has been severely affected by the pandemic.
Even with pandemic effects and supply chain woes, existing home sales are the highest they have been since 2006. This 15-year record has been fueled by low mortgage interest rates and strong demand. The inventory fell to lowest level since January 1999, keeping home prices elevated and pricing out first-time buyers.
How is the HOI calculated?
The housing cost calculation takes into consideration the price of homes and the interest rate.
For income, NAHB uses the annual median family income estimates for metropolitan areas published by the Department of Housing and Urban Development. NAHB assumes that a family can afford to spend 28 percent of its gross income on housing; this is a conventional assumption in the lending industry. That share of median income is then divided by twelve to arrive at a monthly figure.
On the cost side, NAHB receives every month a CD of sales transaction records from CoreLogic. The data include information on state, county, date of sale, and sales price of homes sold. The monthly principal and interest that an owner would pay is based on the assumption of a 30 year fixed rate mortgage, with a loan for 90 percent of the sales price (i.e., 10 percent downpayment). The interest rate is an average of the 30-year fixed effective rate from Freddie Mac’s Primary Mortgage Market Survey during that quarter. In addition to principal and interest, cost also includes estimated property taxes and property insurance for that home. This is based on metropolitan estimates of tax and insurance rates from the the most recent American Community Survey. Mortgage insurance is not currently a component of the HOI.
Therefore, for each record, there is an estimated monthly cost and available income share. The HOI is the share of records in a metropolitan area for which the monthly income available for housing is at or above the monthly cost for that unit.
The Effect of Interest Rates on Affordability
Today’s 6% rates have made an impact on housing affordability. Rising 3 percent may seem small, but that rate increase reduces the amount the borrower can spend.
However, these rates are still historically low…Some history:
The average 30-year fixed-rate mortgage hit record lows 16 times in 2020. Then in January 2021 we saw another record low of 2.65%, the lowest level in its nearly 50-year history. As inflation rears it’s ugly head, we are starting to see interest rates rise. In mid-January 2023 the rates are around above 6%.
Just to put this in perspective…Only five years ago rates were 4.5%. In the 80’s rates were in the double digits (as high as 16%!), going as high as 18%. In the 90’s rates bumped up and down between 7% and 9.5%. (our first mortgage was 8. something%!) During the 2000’s we saw 5% and 6% regularly, and we thought it was incredibly low! Some said even too low, fueling the wrong kind of investment. The last decade saw many record lows as rates hovered around 4% for most of the decade.
To understand the impact of interest rates on affordability, read this handy chart: Interest Rates and Home Affordability.
For income, NAHB uses the annual median family income estimates published by the Department of Housing and Urban Development. They use the figure of 28% of gross income as an average amount that homebuyers can afford to spend on housing.
Divide the 28% of average income by 12 to come up with a monthly amount allowable for a mortgage. This is a much more conservative percentage than most lenders use.
Keep in mind that the FHA guideline maximum debt to income ratio is 56.9% with compensating factors. Lenders can, and most lenders will, limit maximum debt-to-income to under 55% and some lenders to 45%.
So, affordability calculations are much more conservative than reality. We can truthfully estimate that housing affordability is higher than the HOI reports.
Rent vs buy – explaining housing affordability in Frederick Md
When explaining housing affordability, remember that local markets are different. While the National Affordability Index is at 38.1%, which gives us a view of the way housing costs are trending, that’s not helpful to anyone asking about affordability in their particular location… local markets vary.
Washington DC, NVA, MD HOI
Frederick is considered a sub-market of Washington D.C., yet much more affordable. Washington D.C. has an affordability index of 46.63%. The median family (of 4) income for the area is $$139,000 (according to HUD) the median home price is $500,000. As we move out from Washington D.C., home values decrease, like concentric circles.
Frederick MD HOI
The median income for Frederick Md households is $100,000, according to DataUSA, which uses a broad group of sources, and the median home price in Frederick is roughly $450,000. Incidentally, without an exact number, we can see that the affordability index for Frederick is higher than Washington D.C., Rockville and Bethesda, primarily because of home values.
Hagerstown-Martinsburg MD-WV HOI is 77.5%. The median home price is $265,000; the household income is $77,500.
Incidentally, the 5th most affordable area nationally (2nd regionally) is Cumberland Maryland, where 82.9% of households (with an average income of $71,300) can afford the median-priced home of $130,000.
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Rent Vs. Buy in Frederick Md – Some History
Buying a home is not for everyone all the time; sometimes it’s a good idea for a particular time, sometimes it’s a good idea to wait, and sometimes people shouldn’t buy a home. Here are some facts and statistics to help you decide when it’s the right time to buy or rent.
Whether to rent or buy a home is a personal choice, based on a lot of variables. Sometimes it involves more than just numbers.
Home values were declining from 2006 until the summer of 2012. The first 2 years of decline in home prices were in the double digits, but the next 2 years slowed to less than a 5% decline. Then we saw the leveling off of home values here in Frederick County, and since 2014, we’re experiencing increases in the area. Homes above $600K are increasing at a (slightly) slower pace…(but they have been catching up!) than homes priced under $400K.
Should I Rent or Buy?
Given the fact that Frederick County is very affordable, compared to metropolitan areas nearby, and given the fact that home values are on the rise, let’s establish that it is generally a good time to get into homeownership. The real questions you must answer are about your personal situation.
For some people, buying a home makes the most sense, and for others, renting is best. It is a well-known fact that for most Americans, owning a home is the main vehicle for building wealth over time. You have to live somewhere, right? When you are paying rent, you are paying someone else’s mortgage.
Here are six questions to help you determine if 2021 is the right time for YOU to buy. Note: Some of the answers might surprise you so read on…
1. Do you have some savings?
Even though there are a number of zero down payment programs, you must plan for closing costs and many other one-time expenses as a homeowner. Insufficient savings may not prevent you from buying a home but it is a strong indication that you may not be prepared for the ongoing financial requirements of homeownership.
How much should you have saved? It depends on what price range you are considering, as well as the loan you will be using.
With an FHA financed loan, you will need to have 3.5% for a down payment. On a $325,000 home that is $11,375.
For most first-time buyers, FHA loans are a great choice, with low-downpayment and common sense qualification criteria. But there are also conventional loans and VA loans to consider. The downpayments will vary with each loan and each lender.
The Maryland Mortgage Program is a great loan program for first-time buyers (and repeat buyers) in Maryland. The program offers several types of down-payment assistance. As with most state programs, there is an income limit with MMP, which is up yo $176,400 (depending on household size and targeted area) for Frederick County. The mortgage rates are very competitive with other loan programs. Be sure to read the details in the linked article, and contact us for an MMP qualified lender.
You will have some other expenses, like the home inspection, typically $500 to $600.
You may have some closing costs, like origination fees, and fees from the title company, typically 2% to 3% of the purchase price. Sometimes buyers can negotiate with the seller to pay closing costs, but its best to be prepared.
How much do you need for a downpayment on a home? Bill Gassett, MA Real Estate Agent, has an informative article explaining downpayments and gives several pros and cons for the size of your downpayment. He’s got several suggestions for coming up with a downpayment.
2. Are you Creditworthy?
Your credit score is an important asset. Your lender will consider your score as an indication of your creditworthiness. Typically, the higher the score, the lower your interest rate.
Additionally, your credit history is important. While you can always find a lender to lend you money, you’ll pay exorbitantly high rates. Solid lenders are more skeptical if your credit history is not good.
Minimum Scores. While FHA and Freddie and Fannie have minimum scores, (A minimum of 580 is necessary to make the minimum down payment of 3.5%.) many lenders have their own requirements. (FICO credit scores start at 300 and go up to 850.) Most lenders require a score of 620 to 640 to qualify.
The higher your credit score, the lower the risk you are. The lower the risk you are, the lower your interest rate. Shoot for a high credit score, not a minimum score.
How to Build A Credit Score Lenders will Love
3. Is your employment steady?
While we can never predict the future, you probably have a sense of your job or business security. If you’re working for a start-up company, you probably want to wait for a secure situation. The last thing you want is to saddle up with a mortgage and then find yourself unemployed, or underemployed.
4. How much debt do you have?
A lender will calculate your debt-to-income ratio, which is different for each loan product. Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. A conservative number to shoot for is having a mortgage that is 28% of your income. This is called the front-end ratio.
Most mortgages have a maximum back-end debt-to-income (DTI) ratio of 43%. The back-end ratio takes all your debt into account. There are some programs with higher front-end and back-end DTI ratios…which make us nervous, to tell the truth.
You can do a quick calculation and decide how you fare in the category of debt. To calculate your debt-to-income ratio, add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is the amount of money you have earned before your taxes and other deductions are taken out.
If you are thinking about a home purchase you’ll want to plan ahead to minimize your debt. You’ll want to consider foregoing a new car purchase, or charging the new furniture on you credit card. You might want to pay down your credit cards and pay off some debts.
This is why we like to say: Buying a home is a process, not an event.
Luke Skar, with Madison Mortgage Guys, has a helpful tutorial showing you how to calculate your debt-to-income ratio. The calculations are not difficult, but it is important to remember that each kind of mortgage will have slightly different guidelines for their qualifying DTI ratios.
5. Are you going to live here for a while?
Again, we can’t tell the future, but you’ll want to be sure that you can stay in your home for a minimum of five years. If you expect to get a job transfer within a few years, you may end up paying money in order to sell it. You’ll want to make sure your home value increases enough to cover the costs to sell your home.
The length of time that it will take to cover those costs depends on various economic factors in your area. Normal appreciation is considered an average of 3-5% per year. This is considered normal and healthy and should cover selling costs in about five years, given normal conditions.
What we are experiencing since 2020 is NOT normal appreciation. In the last year we’ve seen approximately 20% appreciation of home values, on average!
Remember, real estate is local. Something to consider: If the area you buy your home in experiences an economic upturn, the length of the time to cover these costs could be shortened, and in the unfortunate circumstance of an economic downturn, the opposite is also true.
6. How long will the home meet your needs?
What features do you require in a home to satisfy your lifestyle now? Five years from now? Depending on how long you plan to stay in your home, you’ll want to make sure that the home has the amenities that you’ll need.
For example, a two-bedroom home may be perfect for a young couple with no children. However, if they start a family, they could quickly outgrow the space. Therefore, they should consider a home with room to grow.
While we don’t ever encourage buyers to stretch beyond their comfortable capacity to purchase, we do caution against getting a home that is too small, or that will not suit their needs in the next 5 years.
If the home has room to grow, consider the costs of improvement, or your ability to DIY. Could a basement be turned into a den and extra bedrooms? Could the attic be turned into a master suite, or a bonus room? Having an idea of what features you’ll need in the near future will help you find a home that will satisfy you for years to come.
7. Are you ready for the responsibility of homeownership?
There are costs and responsibilities with homeownership that most renters are not accustomed to, things the landlord took care of. Home insurance, home maintenance and repair, appliance replacement, and home maintenance and repairs are all important considerations. Most experts suggest you save 1% of your home’s value every year. Saving for long-term projects, like replacing the roof or the HVAC system, will save you the emergency of the cost of replacement when there is a sudden breakdown of a major system, or the inevitable replacement because of age.
Your home is probably the most expensive purchase you will make in your lifetime. It is a place to build your nest, both figuratively and literally…your financial nest egg. You will want to take care of the maintenance of your home regularly to maintain its best value throughout the years you own it.
? Have you saved money by putting off your home purchase?
Even though home prices are rising, the cost of buying is still low, compared to past years. Interest rates are the major factor in the cost of a home.
Look how the changing interest rate affects the monthly mortgage:
Eric Jeanette, over at Dream Home Financing, has some great advice on how to find the lowest mortgage rate. With so many internet lenders and options, the information can be confusing especially when you start to compare the various fees.
Is This the Right Time to Buy a Home in Central Maryland?
Once you have considered the finances, your future employment, and your savings, the decision is really about lifestyle. For most Americans home ownership is the most likely method to build wealth.
It is also a way to create a lifestyle that best suits you and your family. Those intrinsic desires are best accomplished in your own home…paint the walls the way you want, plant a garden, get a swing set, and enjoy the freedom to build a nest, both financially and emotionally.
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Chris Highland, Broker eXp Realty Maryland
Cell: 301-401-5119 Broker: 888-860-7369
Rent vs buy – explaining housing affordability, written by Chris Highland, Associate Broker, eXp Realty. We hope it helps with your homebuying plans!
Our real estate team has spent over 30 years helping people in Frederick County and the surrounding area in Central Maryland determine if homeownership is right for them.
If 2023 is your year, give us a call and we’ll help you find your nest. Contact us for our preferred list of lenders. We can find a loan program that fits your situation.
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