In the last decade, the housing market in the United States has undergone a transformation. Newcomers hunting for their first homes are finding higher prices in many locations since the lows of 2008 and 2009. At the same time, they’re having a harder time getting the tax breaks that once helped offset the costs of hefty mortgages.
Despite these realty realities, buying a home that fits your wish list in terms of price, location, size and condition could be a great investment. Unlike monthly rent checks, every mortgage payment on a home can be viewed as an investment. And mortgage interest rates are extremely low—the average rate as of October 2019 was 3.77% for a 30-year mortgage.
Here’s a look at recent changes in the housing market—good and bad—as well as a few ways to make your first new home work for you.
The Price of Entry
Millennials between 25 and 34 are 8% less likely to own a home than Gen Xers and baby boomers when they were the same age, according to a 2018 Urban Institute study. Housing experts point to several reasons for this. First, millennials are saddled with far more student debt than their elders, and that makes it harder to save for a down payment on a home. As a result, they tend to put off life events that often trigger home purchases—marriage or having kids—until they are older.
The other reasons, rooted in financial barriers. are closely tied together. For a so-called conventional mortgage, some banks, co-ops, and condos require buyers to make significant down payments, usually 20% to complete a purchase. Additionally, as prices climb in a seller's market, a down payment can be pretty steep. The higher a home’s sticker price, the more cash you may need to qualify for a loan.
This can be an intimidating barrier to becoming a homeowner. The average price of homes purchased by first-time homebuyers was $219,300 at the end of 2018, according to The National Association of Realtors. A 5% down payment on the average first house would be $10,965, and 20% would be $43,860. While that may seem like a fortune to some, it’s an obstacle that can often be overcome through smart saving.
Lending Alternatives
Fortunately, the 20%-down-payment requirement isn’t the only way to get a mortgage. Most first-time buyers put down an average of 7% in 2018, thanks to a variety of mortgage instruments designed to help buyers make that initial purchase.
Newcomers with a credit score minimum of 620 need to make only a 3% down payment to qualify for Fannie Mae’s “97 Conventional” single-family home loans. This program, driven by U.S. government funds, is also called the 97% loan-to-value, and mortgage companies can use the program to issue qualified loans. Fannie Mae also offers HomeReady, a second 3% down payment program, which is available to households in lower-income neighborhoods and in minority-heavy areas.
Some lenders accept lower down payments if the borrower takes out mortgage insurance, but this can be expensive. The pricing on these policies is based on the total loan amount. So a policy that charges 1% on a $200,000 loan would cost $166.66 a month. That’s $2,000 annually, or $60,000 over the life of the loan.
Down Payments vs. Savings
But the catch with small down payments is that a smaller down payment means a bigger mortgage. And the bigger the loan, the larger the monthly costs to buy your home. So prospective homeowners may want to focus on building their savings before buying property.
The current generation of new home buyers is taking almost 50% longer to save for a down payment than their parents. For a short-term goal like saving for a home, many will choose to steer clear of volatile markets. They may opt for high yield savings accounts, certificates of deposit or money market accounts, which also allow you to write a number of checks and make withdrawals each statement period.
These accounts have the added appeal to home buyers competing for houses in a competitive market because they allow instant access to your cash, although some penalties for early CD withdrawals may apply.
Taxing Realities
Before, during and after a home purchase, you will need ready access to thousands of dollars to cover closing costs, such as an appraisal fee, housing inspection fee, your attorney’s fee, a title search and homeowners' insurance among others.
There are also real estate and mortgage brokers who charge for their services, so you may need about 5% of your total mortgage amount to cover all the costs. While some borrowers bake the cost of the closing fees into their loan, it is more cost-efficient, in the long-term, to pay them off as one-time expenses.
After you buy a home, you’ll have to pay annual state and local taxes (SALT) on it. While those taxes were deductible on federal income tax returns under the Tax Cuts and Jobs Act passed in 2017, that deduction was slashed. Homeowners now only deduct a maximum of $10,000 each year in SALT expenses.
So house hunters should take time to add up all of the local levies on potential properties, especially in heavily taxed suburban towns. Look for low-tax districts. Even in states where the average SALT deductions exceed $10,000 a year—California, Connecticut, Illinois, Maryland, Massachusetts, Rhode Island, New Jersey and New York—there are homes whose tax burdens fall below that $10,000 threshold.
Buyers who are looking at markets like New York or San Francisco, where average home prices top $1 million, should note the Tax Cuts Act also slashed allowable interest payments deductions. Previously, $1 million mortgage holders could itemize all the interest paid on their loans. That amount has been capped at $750,000 for anyone buying a home after 2017.
The Money Pit or the Windfall?
The numerous expenses involved in becoming a home buyer can be daunting. So it’s worth remembering that there’s more than one way to value a home.
There’s the market value, the amount you have invested in it and the amount you paid off on your mortgage. These are pure equity-building investments.
But there are other dividends—the community, the schools, your friends, and the peace of mind of owning your own home. These don’t show up on a balance sheet, but they are some of the rewards that justify the risk.
Seth Kaufman is a journalist and ghostwriter based in Brooklyn. His work has appeared in The New York Times, The New Yorker online and many other publications.
Read how one millennial super saver bought her first home at age 26.