Buying A Home Is The Cheapest It's Been In 20 Years

Have you heard of the 36% rule to qualify for a mortgage?

It means your total monthly debt payments shouldn’t be more than 36% of your monthly income before taxes.

Millennials are being smart about home buying. The vast majority — 76% — are spending less than 30% of their monthly income to pay the mortgage. That’s not apples to apples, but it is a good indicator of today’s home affordability.

Although the actual cost of buying a house certainly hasn’t gone down, buying as a percentage of income is the same or less than 20 years ago.

A Harvard University study showed that “price-to-income ratios peaked in 226 of 382 metro areas between 2005 and 2009.”

If you’re sitting on the sidelines waiting for prices to come down, you might want to reconsider and instead unfold that moving checklist.

What Should You Be Considering Instead Of Listing Prices?

You’ll just keep suffering sticker shock if all you do is look at listing prices that historically have always gone up.

Millennials took away a bad lesson when home prices nosedived in 2007 and didn’t begin recovering until 2011. That's because it was one of the biggest abnormalities the housing market has ever experienced.

A better metric to watch is your income-to-debt ratio, along with wage growth and interest rates.

Interest on a mortgage costs much more than the list price. Working on and completing your moving checklist should be based more on obtaining the right 30-year interest rate than a $2,000 drop in the listing price.

If the listing price drops, you’ll probably be sorry. If interest rates remain near historic lows, you’ll be happy.

Buying into dropping home prices is much riskier financially than buying into a rising market. In a rising market, you’re building equity every minute of every day. If prices were to start dropping, you’d be worried every day if you have any value at all remaining in your house.

Rising Markets Build Wealth

Certainly, you’ve heard of the supply and demand curve that applies to marketplaces. In residential real estate, the basic formula is: when household income rises and mortgage interest rates fall, a homebuyer’s purchasing power increases.

A 1% change in the cost of a home and a 1% change in interest rates are nowhere near the same thing.

If the price of a $200,000 home goes up 1%, you’re paying $2,000 more for the home. If mortgage rates go from 3.7% to 4.7%, the difference you’ll pay over 30 years is $42,016.

The 1% increase in interest costs over 21 times more than the increase in the home price. Maybe you don’t plan to live in the same house for 30 years, but you’re probably going to be paying a mortgage for 30 years.

Those are real dollars that you’ll pay out.

Even on a monthly basis, your payment will increase $117. In less than two years, you’ll have paid more for higher interest than for the listing price increase.

Next, factor in that you’ll probably only put 3% of your own cash into buying a home. That’s a good reason you should be happy that prices are steadily going up 5% to 7% each year.

That mortgage is also known as “other people’s money.” Your 3% cash investment buys a 3.5% interest rate for a $200,000 home. You're earning 1.5% to 3.5% in home equity on the entire $200,000 using other people’s money.

These example numbers are close, but not perfect. The point to take away is that the actual price for a home is less or close to what it was 20 years ago after adjusting for wage growth, inflation and interest rates.

If you do the math correctly, you’re leaving a lot of money on the table waiting for listing prices to go down.