I Asked An Economist 4 Big Questions About Why Home Prices Are So High Right Now

·9 min read

Buying a home can be a huge life decision, whether it’s your first or third time getting a new property.

Couple holding the keys to their new home

If you’ve looked at recently sold home prices on sites like Zillow lately, you’ve probably noticed how housing prices have skyrocketed since the start of the pandemic. In fact, the typical price for a home in the US has increased by 13.2% since last year, according to a Zillow report.

You might have a lot of questions, like:

Will prices stay high like this?

Should I wait until they come down (if this even happens)?

Are we in a housing bubble?

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So what’s the deal with the housing market right now? More importantly, how does it affect you? I spoke with economist Mike Schenk to shed some light on these important questions:

1.First of all, what is a housing bubble?

A model house in a bubble

A housing bubble is when real estate prices suddenly spike high and the demand for homes outpaces the supply. This is often a temporary situation but can last for several years. Eventually, a factor comes into play that either causes the demand for homes to decrease or stall. As a result, prices may fall, and the bubble bursts.

The most noticeable recent housing bubble occurred in the mid-2000s between 2007 and 2008. During this time, there was a rapid increase of credit supplied by banks and other lenders combined with looser standards of credit underwriting and the typical requirements needed to buy a home.

In other words, it was much easier to become a homeowner due to fewer strict requirements. This backfired when the recession hit and some borrowers were not financially equipped to pay for their mortgages. They lost their homes, and there was suddenly a surplus of foreclosures and plenty of inventory in the market.

Housing bubbles can be a little scary because things can seem "good" or "prosperous" in the beginning, but ultimately, the situation is unsustainable in the long term, and the bubble bursts.

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2.So are we in a housing bubble right now?

A model of a house next to a stack of coins and a calculator

This is the biggest question potential homebuyers are facing right now. But the answer is both yes and no. "Yes" in the sense that home prices have noticeably spiked. "No" in the sense that the housing market is definitely not in the same shape it was in before the 2008 crash. This means that we likely won’t see a big burst as we did back in 2008, according to Mike Schenk Deputy Chief Advocacy Officer for Policy Analysis and Chief Economist at the Credit Union National Association (CUNA).

“We’re definitely seeing prices increase rapidly in some markets, and the increase is unsustainable,” said Schenk. “However, we shouldn’t expect a bubble that’s going to pop, but adjustments will likely be made over time. ”

Schenk explained that while we're not in a bubble comparable to 2008, there are some concrete reasons why home prices are rising so quickly. Some factors that he attributes to what he calls a current speculative housing bubble include:

Demand - The demand for housing has increased, but there is not enough supply to meet this need. Thus, prices are driven up.

Labor shortage - There is also a shortage of workers who are qualified to build homes, since some of the people employed in these industries retired early in the wake of the pandemic.

Higher cost of materials - It’s no secret that the cost of raw materials needed to build homes has increased as well over the past year.

According to the Federal Reserve, American household debt is at an all-time low.

“When the pandemic hit, disposable income went up due to unemployment benefits and the stimulus package,” said Schenk. “For more than 10 years, debts outstanding as a percentage of take-home pay has been declining. This means that consumers (on average) are in a much better place financially to buy and keep their homes.”

According to NBER.org, most households used 30% of their stimulus checks to pay down debt, and another 30% went to savings.

According to Schenk, we could be looking at all this data through a lens of an improving economy. Unemployment rates are falling, and more and more people are getting back to work. Still, as an experienced economist, he warned that people should be cautious with their money since we’re still in an unpredictable pandemic.

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3.What financial factors should you think about if you want to buy a home now or pretty soon?

Whether you’re looking to buy a home next month or in the next year or two, it’s important to prepare your financial situation well in advance. Here are a few things you’ll need to consider when buying a home — especially given the current housing market.

Income Stability

Person counting money

Since your mortgage payment will probably be one of your highest long-term expenses, it’s important for lenders to see that you have a stable and consistent income.

Things happen, whether it’s a medical emergency or an economic recession. But the key is to make sure you have stable employment and a consistent income so you can continue to pay your mortgage even when months are tight financially. Lenders may like to see that you’ve been at the same job for a while, but they may also take the time spent in your career field into account as well.

This means if you’re an accountant who just landed a new job a few months ago, letting your mortgage lender know you’ve been in this particular career field for several years now could demonstrate income stability over time.

While no job is 100% stable, a good rule of thumb is to try to keep your overall housing costs at or below 30% of your income. That way, you can be confident that you’ll still be able to afford your mortgage payment if your income goes down slightly in the future.

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Your Credit

Credit report

The higher your credit score is, the lower your interest rate might be for a mortgage. Most lenders use the FICO scoring model, which ranges from 300 (poor credit) to 850 (excellent credit). While you can still qualify for some types of mortgages with lower credit scores, you will pay thousands of extra dollars in interest over the life of the loan.

Here are two examples of how much difference even just one percentage point makes when considering your mortgage interest rate, calculated using this mortgage calculator. (These scenarios assume a 30-year repayment term.)

Scenario A

Home price: $250,000

Down payment: $40,000

Interest rate: 3.8%

Monthly payment: $1,349.34

Total interest paid: $142,263.76

Scenario B

Home price: $250,000

Down payment: $40,000

Interest rate: 2.8%

Monthly payment: $1,233.71

Total interest paid: $100,636.20

As you can see, locking in an interest rate that's just 1% lower can give you a lower monthly mortgage payment and eliminate more than $40,000 of interest over the life of the loan.

If you're not already keeping an eye on your credit, you can start by checking your credit score and full report. You can get your full credit report for free once a year at AnnualCreditReport.com. And you might also like to check out these tips for raising your credit scores.

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Your Savings

Person holding a jar of change labeled savings

You don’t need a 20% down payment to buy a home, but putting 20% down could help you avoid paying Private Mortgage Insurance (PMI), which will save you money. Also, putting more money down initially could decrease your mortgage payment.

Aside from your down payment, it’s important to also have some money saved up for closing costs, repairs, and maintenance. Closing costs can make up around 3% to 6% of the home’s purchase price. Whether you buy a starter home, a fixer-upper, or your dream home, it’s always important to prepare your savings for any potential repairs and necessary maintenance. You never know when something will break, and it’s your responsibility to fix it.

Set a savings goal based on your budget for a house and how much you’d like to put down. Then, factor in maintenance costs, and increase your emergency fund as well. You can set up automatic transfers from your checking account to your savings account to help you stay on track.

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The Market You Plan to Buy In

Key in the lock of a home's front door

Thoroughly assessing the housing market in the specific area where you want to buy can help you make the best decision about your housing purchase based on your situation. The best part is that you don’t have to be an economist or mortgage expert.

The National Association of Realtors website is a great place to find housing statistics and see how prices have increased or decreased. Zillow.com is another helpful resource. Most people use Zillow to search for housing, but you can also review Zillow’s studies and compare properties you find on the site as well. Zillow can tell you the average number of days a home stays on the market in your area. You can also review homes that have recently sold and see if there’s enough inventory available that meets your criteria.

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4.So is buying a home during a housing bubble a good idea?

Woman looking at paperwork at home

Buying a home is a personal decision that really depends on your unique situation. However, it’s not possible to ignore the economic factors that can come into play. If buying a home during a housing bubble means that you’ll be paying more than it could be worth in the future, then it probably isn’t the best idea.

Still, everyone faces this risk regardless of when you buy. Even if the market is completely normal, your home could lose value in the future.

“In a hot housing market, I would think about putting off a purchase until things calmed down to avoid overpaying,” said Schenk. “If I had the flexibility, I’d consider renting in the meantime, but I know not everyone has that flexibility or tons of options.”

When it comes to the future, Schenk said he expects the home value appreciation to slow down significantly in the months ahead, so waiting could be a good way to scope things out and avoid a vicious bidding war.

That said, it’s understandable that some people have the wherewithal to buy in this market, and they are. So long as it makes sense for you financially, there’s nothing wrong with snatching up the home you truly want right now either. Ultimately, the key is looking at your financial situation from a long-term perspective and considering how sustainable your decision will be in the future.

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Are you hoping to buy a home this year or in the near future? Share how you're planning for this purchase in the comments.

And for more stories about life and money, check out the rest of our personal finance posts!