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Is The Next Housing Market Crash Coming?
SAN DIEGO, CA – “Buy low, sell high‘ is a well-known saying attributed to legendary billionaire investor and philanthropist Warren Buffett. Looking at today’s super hot housing market, it’s hard not to wonder how much longer this madness will continue.
Buyers are in bidding wars to purchase homes, multiple all-cash offers with no financing, no contingencies, sale prices tens or even hundreds of thousands of dollars above asking prices, double-digit annual home appreciation, and very little inventory of homes for sale.
According to the Case-Schiller Home Index, the average annual home price appreciation in the 20 largest metropolitan areas was 14.6% year over year as of last May. Phoenix had the largest annual price increase at 22.3%, followed by San Diego at 21.6% and Seattle at 20.2%.
I distinctly remember that in 2005-2006, at the height of the last super hot housing market, many were saying that the market would continue to boom and prices would rise for at least another ten years.
Yet by 2007, home prices began to deteriorate, and by 2009-2010, a wave of short sales and foreclosures dominated the previously super-hot markets. The hardest hit places like Phoenix and Las Vegas have seen property depreciation in some cases over 50%.
But this time it will be different… no. If there’s one thing that’s certain about real estate (and life in general), it’s that it’s cyclical. Every boom is followed by a crash, and every crash by an eventual recovery and then another boom, and so on.
In the case of real estate, cycles tend to be much longer than those of the general economy, lasting about 15 years on average. In this particular case, it is important to note that we are discussing a residential (home) real estate cycle, which can be quite different from a commercial (investment) real estate cycle.
So where are we today? Interest rates, including on mortgages, are at extremely low levels. For example, our mortgage subsidiary recently closed 15-year fixed rate loans as low as 1.99%. This is quite remarkable considering the rate of inflation is staggering. Last June alone, inflation jumped by 5.4% on an annual basis.
This was the biggest increase in inflation since 2008. At this rate, the US is on track to have double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4% in 2018 and 1.8% in 2019 and 1.3% in 2020 .
The federal government’s money supply, national debt, and public spending are enormous. It seems that not too long ago, when politicians were arguing about the federal budget, they were talking about millions or at most billions of dollars. Now, if it’s not a trillion, it doesn’t seem like a big deal.
US unemployment has been steadily improving since peaking at 16% in May 2020. As of early June, the unemployment rate was around 5.9%. However, these figures can be misleading as they do not include people who are “underemployed”, e.g. have moved from full-time to part-time work, or those who earn less now than before the pandemic.
Furthermore, they do not count workers considered to be “permanently unemployed” (out of work for more than six months) and those who “stopped looking for work”. “Real” or so-called U6 unemployment is around 9.7%.
So how does all this translate to the housing market? The current real estate cycle is about 15-16 years old, which is alarming, but essentially, while money is so cheap, buyer demand is so high, and the supply of available homes for sale is so low, “the music keeps on playing.” playing.”
Also, we should not underestimate the “Covid-effect” on housing. One of the reasons homes became so valuable was because of lockdown and the resulting paradigm shifts to work from home, teach from home, play at home, and eat at home.
If cycles are the law of the universe, then it is safe to assume that this cycle must also change. When? No one knows for sure, as we only know the cycle has changed after it has already changed.
However, in my view, the catalyst for change will be an increase in short-term interest rates by the Federal Reserve, which will have to happen sooner or later given high inflation.
Our real estate agency receives many inquiries from buyers and investors looking to purchase properties. In our opinion, real estate buyers should exercise extreme caution in such an overheated real estate market.
Double digit annual price appreciation is absolutely unsustainable as real wage increases are in the low single digits. It is important to understand that real estate is not a very liquid asset and there are significant costs associated with selling it.
For most homeowners, real estate should be a long-term play, and buyers should take this into consideration when considering a property purchase. When the inevitable market correction occurs, home equity can be significantly reduced or even wiped out in the case of heavily mortgaged homes.
In such cases, property owners can find themselves “upside down” on their mortgages, meaning they will owe more than their properties are worth. Short sales and foreclosures will once again become familiar terms.
On the other hand, lucky homeowners who currently own highly appreciated real estate may be in a perfect position to cash in on their equity now that the market is hot and prices are high (remember what W. Buffett said).
Residential homebuilders, particularly those building in the lower price ranges with projects already underway or on track to go vertical and deliver completed homes in the next 12 to 18 months, are in good shape as the current buyer demand far exceeds supply.
However, after this time frame, it’s anyone’s guess. Exorbitantly high material prices, high land and labor costs and heavy government fees make it difficult for builders to deliver affordable houses and make a profit.
There may be another important consideration for selling sooner rather than later: Uncle Sam. The current administration is openly talking about raising taxes, and despite their campaign promises, it won’t just affect the “rich”.
For example, under their latest tax proposals, homeowners’ exemption from capital gains taxes on the sale of primary homes could be greatly reduced or even eliminated altogether. Oh, by the way, the capital gains tax rate is also going up.
Another significant tax change on the horizon for those who own investment property, even if it’s a small rental house or co-op, is a proposal to reduce or eliminate the so-called “1031 tax exchange,” under which capital gains taxes can be deferred investment properties, including small and large rentals.
Every situation is unique, but my general advice to clients looking to buy real estate now is that there must be a compelling reason to do so. I recommend being patient and not giving in to the madness that will pass sooner or later.
Again, let’s remember what W. Buffett says about buying low and selling high, and he certainly has the experience (and bank account) to prove he knows what he’s talking about.
For clients who own real estate and want to hold on to it for the long term, I recommend reviewing their mortgages and interest rates (if they have loans on their properties).
If it’s helpful, they should consider refinancing it, with or without a payoff, to take advantage of these extremely low interest rates, which are currently well below the rate of inflation, making it practically “free money.”
For clients who are considering selling or have shorter-term ownership plans, this can be a great opportunity to review their property values and determine if selling now, while the market is super hot and prices are super high, is a good idea.
In conclusion, no one knows what the future holds, but a few things are certain: real estate is cyclical and change is inevitable. The current residential real estate market cycle is mature, prices are very high, and therefore it is reasonable to expect a market change.
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