Should You Be Worried About Rising Home Prices?

Home prices may have been rising over the past year, but an analysis by the Economist magazine highlights the fact that housing prices in the United States are still reasonable. Rising mortgage rates may prove to be more of a worry, but there are strategies you can use to adjust to these changing market conditions.

Home Prices Bounce – But not Too High

Lately, the S&P/Case-Shiller Home Price Indices have shown a sustained recovery in housing prices. The S&P/Case-Shiller composite of 20 major metropolitan markets is up by 10.87 percent over the past year, and home prices in each of those 20 individual markets have moved higher during that period.

Still, even though housing prices have bounced since hitting bottom, they have not yet come close to regaining the heights of the housing boom. The 20-city composite is still down by 28 percent from its 2006 peak, and not one of those 20 metropolitan areas has seen its housing prices fully recover to peak levels.

Of course, those peak levels are now seen as the product of a speculative bubble in real estate, so they aren’t necessarily the best benchmark of affordability. To use some more down-to-earth measures, the Economist looked at housing prices relative to rents, and also relative to incomes. Overall, the S&P/Case-Shiller 20-city composite is well below its long-term average levels relative to both rents and incomes. Only three of those twenty metropolitan areas (Boston, Denver, and Portland) are notably above their long-term averages relative to area rents, and only three (Denver, Los Angeles, and Portland) are notably above their long-term averages relative to area incomes.

In all then, housing prices still appear to be at reasonable levels. However, a bigger threat to home affordability might be rising mortgage rates.

Rising Mortgage Rates

Recent weeks have seen 30-year fixed mortgage rates rise from below 3.5 percent to nearly 4 percent. In dollar-and-cents terms, an increase from 3.5 percent to 4 percent would add $57 per month to the cost of a $200,000 loan. To put this in perspective, that would increase the cost of the loan by 6.3 percent. So, in less than two months, a rise in mortgage rates has tacked more than half as much onto the cost of buying a home than an entire year’s rally in home prices.

What recent conditions underscore is that both home prices and mortgage rates are moving targets. You need to be prepared to make changes in order to hit those targets.

Strategies for a Changing Housing Market

With both housing prices and mortgage rates on the rise, you don’t want to lock yourself into an inflexible position – that might cause you to miss the housing opportunity altogether. Here are some examples of how you can adjust your position to adapt to a changing market:

  1. Apply for an FHA loan. The chief attraction in this situation is that an FHA loan would allow you buy with a smaller down payment. This could get you into the market sooner, before prices and mortgage rates have a chance to rise much further. The FHA is a government agency which insures loans but does not make loans directly, so to apply for an FHA loan you would need to find an FHA-approved lender.
  2. Reassess your budget. You should budget carefully before buying a home, so you don’t commit to a mortgage and then find yourself over-extended. Budgeting will help you identify any discretionary spending which you might be willing to sacrifice in order to better afford a house.
  3. Widen your search. Real estate prices are very location-specific, so look at a variety of different areas in your region. You might find some perfectly nice yet less trendy areas where home prices have not risen quite so quickly.
  4. Downsize your needs. Oversized “vinyl Victorian” houses may turn out to be relics of the housing boom, as home buyers have returned to more moderately-sized houses. If you choose a house based on your needs rather than on trying to impress others, you may find yourself with not only a more affordable property, but also one that is easier to clean and maintain.

Neither mortgage rates nor housing prices are especially expensive just yet, and rising mortgage rates may actually slow the rally in home prices. However, when either or both of these variables is on the rise, it is easy for potential home buyers to feel opportunity slipping away from them. When market conditions are changing, you need to be both flexible and decisive, so you can adapt to the changes and act without hesitation when you find the right opportunity.

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