Holiday Eggnog Debates: "Now is a great time to buy a house!"
Everything you need to know to destroy your drunk uncle.
It's astonishing how your uncle, despite no formal education, is both an economist and real estate tycoon at every holiday party.
Without knowing a thing about what your home preferences are, what your local real estate market is like, or about your personal financial situation, your drunk uncle somehow knows that you need to buy a house now.
This conversation is a typical spinoff of "when you are planning of having kids?", "when's the wedding?", or "Cousin Timmy just bought a house".
Your only three legitimate options are to embrace the onslaught of nonsensical statements, deflect the focus of the conversation to an unfortunate bystander (your brother, for example), or to turn it into a political discussion (which is typically far more painful).
I'm going to assume that you're going to take on option 1.
You will take the stance that housing prices are at historical highs, that it is crucial that you continue to save up for both the down payment and an increased emergency fund (for when things inevitably break), and that long term goals (life planning) need to be aligned with any major purchase decision.
Your Drunk Uncle will likely take the stance that now is a great time to buy because of the low-interest rates, rent is a complete waste of money, that you can likely get approved for plenty of money without putting anything down, and that you need to "grow up" and plant some roots.
Let's work through the debate.
You: "Purchasing a home is a major financial decision that requires careful assessment and preparation"
Drunk Uncle: "You should buy a house immediately and stop wasting money on rent"
US home prices increased by 206% from 2000 to 2008.
As you are well aware, this did not last. Prices fell by approximately 34% when the crash hit (bottoming out in 2012).
8 years later (2020), prices have increased an additional 70% (for a total of 231% compared with prices in 2000).
My apologies for the wall of dates.
In brief, prices are absolutely absurd right now even when compared with 2008 mania levels.
Average interest rates on 30-year mortgages have dropped from 8.05% in 2000 to as low as 3.00% in 2020.
This is a 63% decrease in interest rates but by no means a rational justification for the extreme home values.
A quick example will make this apparent:
I buy a home in 2000 worth $100,000 and pay a 30-year rate of 8.05%.
This translates to $737 in monthly payments.
Using the figures above, this home is now listed at $231,000 in 2020 and rates are 3.00%.
This translates to $973 in monthly payments.
Clearly, the lower interest rate does not compensate for the current prices.
The next piece of the puzzle concerns how much cash you have available to use for the down payment.
If you do not put at least 20% down when you buy this already overpriced home, you are going to have to pay additional money each month for private mortgage insurance (PMI).
PMI can cost you up to an additional 2% each month.
So on a $200,000 house, that's an additional $4,000/year fee.
That being said, you are only required to put 3% down when you purchase a home.
So on the same $200,000, that's $6,000 cash you need to bring to the table.
**There are also a number of closing costs required that total up to an additional 3% to 6% of total loan value - so an additional $6,000 to $12,000 to close the sale
So you could purchase a home by putting down only 3% (+ an additional 6% for closing costs) but you will then pay a 2% additional fee (PMI) until you get to 20% ownership.
Basic math puts this at approximately 6 years of PMI before the 20% ownership requirement is breached.
Additionally, when you buy a home, you need to expect that everything is going to break. This requires that you set aside an extra chunk of change in savings so you do not end up having to get into credit card or other higher-rate debt to cover the costs.
Rocket Mortgage estimates that annual home expenditures range from $3,000 to $6,000/year (1-3% of home value for a $200,000 home) on average.
This translates to - you need to have at least $6,000 set aside in savings for the inevitable.
Lastly, you are likely to switch jobs 4 times within the first decade of graduating from college (for my millennials reading this).
This is important because real estate is rather immobile.
Yes, you can sell the house and buy another one wherever your new job is.
But then, you pay another round of closing costs and are exposed to the risk that you are unable to sell your first home for as much as you paid for it (remember, your home price would have dropped almost 40% from 2008 to 2013 which is likely way more than your ownership percentage).
In conclusion, arbitrarily rushing to purchase your first home because "everybody is doing it" or "my drunk uncle said real estate is always a smart move" is a terrible idea.
Home values are at historic highs (12% higher than even the 08' levels) currently and payments are actually higher than they have ever been despite the lower rates, not accumulating enough cash to use for a 20% downpayment will only further the payments required during the first 6 years of ownership, and it frankly makes zero sense to purchase a home until you are almost positive you will not be laid off or plan on switching jobs in the near future.
2020 COVID BONUS
One last argument to throw at your Drunk Uncle.
The LA Times reports that 15 million foreclosures are expected during January 2021 once the State restrictions on foreclosures are lifted.
Most, but not all, states currently have foreclosure restrictions in place to protect delinquent homeowners.
Add to that that an additional 8.4 million renters expected to be evicted in January 2021.
As a baseline, total foreclosures in 2015 were 1.1 million. and total evictions were 870,000.
Simple economic theory dictates that these massive foreclosures & evictions will destroy property values across the country - thus making purchasing a home for the next 6-12 months a precarious choice at best.