Ask Brian: Is Inflation Increasing the Cost to Buy a Home?

Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].

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Question from Cora outside of Chicago: Hello Brian. Not being a financial genius, all the headlines and chaos around first-time buyers are driving me nuts. For 14 months, I’ve been searching for an opportunity to buy a house without having to get into a bidding war. No luck there. Then, interest rates began to inch higher. That’s not working in my favor either. Now, I’m thinking that this rampant inflation is going to put my first house out of reach permanently. Can you help me decide if I should just throw in the towel now that inflation has become another hurdle to becoming a homeowner?

Answer: Hello Cora. Inflation is a red-hot topic right now, but you are observant that low inventory and rising interest rates remain a big part of the challenge. First, let’s take on inflation both directly and indirectly. A first-time buyer is most likely to notice the indirect effects before anything else. By that, I mean the cost of everything is going up. Two of the most obvious cost increases are at the gas pump and the grocery checkout. Inflation is also hitting utility costs hard. All of those are basics that even people who are diligently saving for a down payment can’t avoid. I’m not even going into luxuries like a new spring wardrobe or summer vacation because people saving for a down payment are going without those and many other luxuries in this chaotic financial market.

Inflation is making it more difficult to buy a home but keep things in perspective. Some inflation is normal. Somewhere close to 2% is expected. The latest inflation numbers are about 7.5%. Not good. However, if you account for normal inflation, the actual effect this is having is about 5%. Still not good but it doesn’t sound as bad as 7.5%. If you can find a few more luxuries or other ways to cut spending by 5%, you can basically tread water against the current rate of inflation.

Still, home affordability is going to get worse before it gets better. We can expect mortgage rates to increase in response to inflation. This is about the amount of money available in the economy. The historically low-interest rates have made it super easy for people to afford everything, including houses. The biggest tool that the Federal Reserve has to slow inflation is raising the interest rate. The housing market makes a good example of how this works. The Fed hasn’t even raised the interest rate yet but just the thought that rates will go up is already being seen in higher mortgage rates. Buyers of a median-priced home are now spending $160 more on a monthly mortgage payment than a year ago, according to Realtor.com. It hurts affordability but it also means a lot of people that were barely qualified for a mortgage are no longer qualified. That means fewer people getting into bidding wars above the asking price. Prices will stabilize when people stop bidding the prices up. That is how higher interest rates slow inflation.

Right now, I’d be more concerned with rising interest rates than with inflation. Mortgage rates are already up, and the first interest rate rise isn’t expected to happen until mid-March. James Bullar, the St. Louis Fed president, recently said he expects interest rates to go up a full percent by July. The stock and bond markets are now gripped by fears of multiple rate hikes this year.

Cora, here is why you should still be strongly considering your first home purchase. The faster you move, the better off you are likely to be financially in the long run. According to a Stanford University study, residential real estate has historically been an “investment safe-haven” during inflationary periods. In the USA, the 1970s were a time of the highest rates of inflation that anyone alive today should be able to remember. Mortgage rates between 15% and 18% were common. However, home prices were not going up at that pace. Today, many (if not most) housing experts think we’re near the top of the market in terms of prices because of affordability. Higher interest rates will only compound this problem. I don’t expect to see interest rates go anywhere near 15% but locking in today is much better than waiting until they reach 5% or 6%, which is very reasonable to expect.

Considering that there are still many more buyers chasing very few houses, we are a long way from a real estate bubble. Interest rates can be expected to go higher but home prices, not so much. Buying before interest rates reach 5% should be the current goal. Home ownership is still the best way for the average American to gain wealth over a lifetime. Homeowners in the U.S. have, on average, forty times more wealth than renters, according to a September 2020 report from the Federal Reserve. Even in today’s chaotic financial world, becoming a homeowner is still a goal worth pursuing.

For first-time buyers, there is never a perfect time to buy a home. It comes down to what you can qualify for and are comfortable with. Home prices, interest rates, and inflation are all part of the mix. Over the next several months, prices will likely stabilize but inflation will drive up interest rates and inflation will make it more difficult to save the down payment. People that can secure a mortgage below 5% in the next few months with affordable payments are probably in the best position to become first-time buyers right now.

What is your take on the chaos in the real estate financial world right now? Please share with a comment.

Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].

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