Welcome to the second post in my Buying or Building a House in This Crazy Market series! As this series evolves, I’ll continue to update that first post with all the links.
Chances are, if you’re here, you’ve already run the numbers for buying a house at some point. It seems insane to buy or build right now, but not everyone has the luxury of choosing when to enter (or re-enter) the housing market.
Right now could still be the right time to buy for you, despite all of the craziness going on. And keep in mind that this is coming from someone who hasn’t had skin in the game for over a decade – so I get what all of the market stuff today means, but I’m not trying to sell you anything!
I’m not going to go through how home financing works, because there are so many fantastic resources for that all over the internet. Instead, I want to highlight some things you may or may not be aware of that affect financing in today’s market, and how to avoid them, plan for them, or use them to your advantage.
Buckle up, folks, because this is a long one.
High Home Values and Massive Competition
In Northern Kentucky, home values never quite fell as much as the rest of the nation. I was a realtor in 2011 during grad school, and while that was a tumultuous time in the nationwide market, it didn’t cause nearly as much home value pain as it could’ve. Don’t get me wrong – lots of houses were overvalued at the time and went underwater, but in general prices didn’t shift downward much on homes that were properly appraised and not driven up in price by a feeding frenzy.
Fast forward to today, and the market competition is ridiculous. Homes are massively overvalued, builders can’t keep up with the demand for housing, and even though we aren’t priced like huge metros, starter home prices are at least double what they were in 2011. I’ve watched the market like a hawk since being a realtor and kept track of growth, pricing, and inventory in my area – it’s absolutely bananas.
We tried multiple times to purchase an exising home in today’s market, and even with a really healthy budget of $400,000 we were still being outbid by $20k, $30k, $50k OVER asking price for homes that would not hold that resale value if the tiniest devaluation were to hit our market. That much money would’ve purchased a well-kept home in the nicest communities ten years ago, and now you’re looking at a decent size house in some decent areas that needs at least a couple major repairs, or a small house in not so great areas that may not need larger repairs (if the remodeling was done well).
While I do think we will eventually see a market correction in this area, if interest rates fall too fast too soon, it’s just going to inflate prices further, which is great for equity if you already own a home, but not so great if you’re trying to buy.
The bottom line is that homes are not going to get massively cheaper than they are today, especially if they didn’t do that during the 2008-2013 period in this area. Every region is different, so this is where a real estate professional is worth having – even though buyers will now have to pay those fees instead of sellers – because they know whether your home is priced to go underwater if the market corrects itself in even a small way and can help you understand when to avoid the bidding war. You do not want to make negative progress on your equity just because things became frenzied while bidding! That’s a hole that will take years to dig out of.
High Interest Rates Have Some Advantages
I always knew that there were tax advantages to owning a home, but I didn’t understand quite how great they were until I had to sign a contract during a time of high interest rates. Mortgage payments and amortization schedules work very similarly to car payments, so for the first ~half of the loan, you’re going to pay more in interest each month than you do in principal, and under current tax laws every single penny of that interest is tax deductible.
(Side note: if you’ve never looked at an amortization table for your loans, you really should! There are awesome calculators online that will give you a fairly accurate approximation of what you’re actually paying each month, how much early additional principalpayments affect your interest – even if they are small – and how much interest you’ll actually be paying each month and year to help you start to understand this all so much better.)
With current rates on approximately $400k loan, that’s more than the entire standard deduction and tax liability for a two income household, even at a higher tax bracket. With my current career, we moved up into the six figure bracket a decent amount so our income taxes became significantly higher; I have an extra $500 per month taken from my checks to make sure we won’t owe at tax time. Going forward, however, the mortgage interest will cover our entire tax liability for about the first half of the loan length, assuming we don’t pay early. That’s not including deductions for property taxes, or child tax credits, etc. so I will be able to stop making those extra tax payments out of my checks in addition to getting a refund on anything that we do pay in federal taxes from our paychecks.
We won’t get the extra money back (it’s a deduction, not a credit), but that still massively helps with paying that higher mortgage interest rate for several years. Also, we will have to adjust paycheck deductions when we start paying less interest, but since I’m still “early in career” after I changed jobs, my pay increases will outpace any tax liabilities that will come as interest percentages start to wind down.
It’s important to say that everyone’s tax situations are different and you should definitely run the numbers with a professional to be sure it will be in your favor, but that could make a huge difference in overall home affordability for you.
Additionally, home prices will spike when rates do come down, so your purchase price will ultimately be lower now even with higher rates, and you can always refinance when rates come down. I would be cautious about thinking they will change too much, however; I doubt we will ever see 3% mortgage rates again in my lifetime, and historically our rates are still lower than those of the 1970s and 1980s even though we feel like they are high right now.
Make sure you’re conservative about how much rates will realistically change in the future, and always base your budget/purchasing power on the terms you’re getting now instead of what they could be at refinance – that’s just an added possible future cushion.
Builder Incentives in Tight Markets
If you’re in a tight housing market like we are, sellers may be super hesitant to accept contracts that include paying for buyer’s closing costs or points, especially in bidding wars, and adding these to competitive contracts often means driving up the purchase price even further to make sure the net seller value beats out other buyers.
When inventories are also tight, builder incentives can often be much more powerful, as prices are not going to be subject to the same kinds of fluctuations that buying an existing home sees. Common incentives include buyer’s closing costs up to a certain percentage, purchasing points that will lower your interest rate (often tied to using their preferred mortgage lender) and/or free refinancing for three years, additional rooms or finishing upgrades that add to your home’s equity when you refinance, etc.
For us, the points from the builder meant we could go up to $440k purchase price to get a significantly larger/nicer home while still staying at budget, and because we took a gamble and didn’t lock in our rates last October, we are seeing those points come off interest rates that ended up going down enough before closing to make our monthly payments even lower than we had budgeted. The points our builder is paying for equalled half a percentage point lower in interest rates. Added to the fact that we got 1,000 sq ft more finished living space and a house that will hold its value above our purchase price even if the market dips, and no major repairs that need doing immediately, for us it was the logical choice. It really just depends on your market and circumstances.
They also offered free refinancing for three years, not including the first six months, which means that when rates do go down, we can easily adjust our rates as many times as we’d like in the time frame. If we choose to pay for another appraisal, we can also potentially have PMI removed early if the value is high enough to raise our equity to 20% or more (which it should be). Additional appraisals are not included in the free refis, so budget for those.
Keep in mind that it’s easy to add on a ton of upgrades that drive up your mortgage, which we will discuss during another post, so keep an average of 10-20% higher home price for upgrades based on nationwide buyer data. Also important to note is that any equity or value above your purchase price will NOT count until you refinance the home; your lender will use the lower of the two from the appraisal and the purchase price. That beautiful $30k morning room they are offering won’t mean anything until you do! Something to consider as you are weighing different incentives across builders.
FHA Pitfalls & Weighing Short-Term versus Long-Term
Lastly, I want to talk about some of the pitfalls of going FHA instead of conventional, and what it actually means for you in practical terms.
We started out on the FHA path for a number of reasons: we made too much money to fit USDA’s stringent income criteria; our max budget kept getting outbid in a tight market so that meant slightly more purchasing power to negotiate with for our monthly budget; and we weren’t sure if we really wanted to put 5% down on an existing home when even the “nice” ones seemed to need at least 2-3 major repairs right at occupancy – that 1.5% down payment difference could mean replacing a major appliance or fixing a drainage issue that was causing damage!
And there’s absolutely NOTHING wrong with going FHA! It’s a fantastic program that we thought was our only way into home ownership for a long time.
However, over the course of building our home, several things changed: our credit scores kept improving to make our conventional rates slightly better than we initially qualified for even before rate fluctuations (conventional rates are always at least a little higher than FHA rates), and as the rates went down in general — coupled with our points buydown — we were no longer sitting smack dab against our top monthly payment. Building also meant zero major repairs at move in to budget for, so regardless of which type of loan we took out, we planned to put down 5%.
When our lender approached us about starting to prepare for closing, she mentioned that a 5% conventional loan might be a better option for us and sent us the detailed breakdowns. Here’s how it ended up:
- Both payments were now at least $200 under our max monthly payment (based on what we felt comfortable with, NOT the max ratios). The conventional payment was about $60/month higher than the FHA payment, but being under our max meant it wouldn’t make things uncomfortable.
- We got much better deals on homeowner’s insurance than the lender had budgeted for, so that (coupled with huge discounts on auto insurance for bundling) made our monthly payments and budgeting better by another ~$120 per month.
- FHA now requires you to pay a large 1.5% fee for PMI at the beginning of the loan, which is tacked onto what you owe automatically. That took away almost $8,000 in equity right from the start! If you are working to make sure you hit that 20% equity mark, going backwards by 1.5% at closing doesn’t seem logical when you have options.
- FHA also now carries monthly PMI fees for the entire length of the loan, so you don’t get to drop it when you get to 20% equity like what automatically happens on a conventional loan. This was by far the biggest factor for us, because we already know going into closing that our appraisal is way higher than our purchase price, so even without additional finishing or updating, we will be adding tons of equity as soon as we re-appraise/refinance – potentially enough to hit 20%. Not being able to drop PMI ever without changing loan types is super frustrating.
- Worse still, despite having an incentive for free refinancing for three years, every refi would cost us .5% of the value because the government requires an additional PMI fee every time you refi. Not cool.
I knew some of this stuff, but now I really understand how it was going to affect us both in the short term (maybe a couple years of having a payment that’s $60 more a month) and in the long term (massive savings, able to pay our house off earlier since we are starting much later and are closer to retirement, etc.). You may look at your situation and FHA is still the better option for you, and that’s wonderful and absolutely fine! It’s important to be informed of the trade-offs and how they will affect you.
Thanks for hanging in with me on this long post – I promise they won’t all be this wordy, but this is a nuanced subject. Many more photos of the build, selections, design plans, and progress coming in all of the rest of the posts!
*Disclaimer: While I was a licensed real estate professional long ago, all content is my opinion only and should not be taken as professional, financial, or legal advice of any kind.
Two Blue Pillars 
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