Middle class homebuyers are taking on $7,000 mortgages with plans to later refinance down

Fast forward to Wednesday, and a $700,000 mortgage was taken out at The current average mortgage rate is 6.90%. It would be worth $4,610 per month, which is $583,000 more over 30 years than the mortgage issued at a 3.1% rate. When you add insurance and taxes, that monthly payment can easily exceed $6,000. Not to mention that this calculation does not take into account the fact that US house prices in June 2022 were 12% higher than December 2021 levels and 39% above June 2020 levels.

Mortgage planners like John Downes, senior vice president at Vellum Mortgage, have the daunting task of breaking this new reality for potential homebuyers. However, unlike last year, Downs says most 2023 buyers aren’t surprised. The loan officer says the sticker shock is fading.

Just before talking to luckDownes ended a call with a middle-class couple in the Washington, D.C. area, who told him they expected a mortgage payment of about $7,000.

“The call I just made was a typical home area. One person makes $150,000 and the other $120,000. So $270,000 total and they said the payout target is $7,000. I’m still not used to hearing people say that out loud,” Downs says.

Even before these borrowers spoke to Downs—who operate in the greater Baltimore and Washington, D.C. markets—they had already concluded that these higher mortgage payments would be “short-term,” and would simply refinance them with a lower payment once mortgage rates fell.

To better understand how homebuyers react to declining housing affordability (and scare inventory levels), luck Downs interview.

This conversation has been edited and condensed for clarity.

Wealth: Over the past year, mortgage rates have gone from 3% to over 6%. How do buyers in the market react to rising borrowing costs?

John Downes: I must say, the reaction today is very different from last year. It is as if we have gone through the “seven stages of grief.” We seem to have entered the “acceptance and hope” phase.

With all the reports of home prices stabilizing, one would think that buyers are comfortable with these rates and the corresponding mortgage payments. The reality is completely different. Many potential homebuyers have been pushed out of the market due to affordability challenges through loan qualifications or personal budget constraints. Moving buyers also find themselves in the same predicament.

As a result, my market (Baltimore DC metro area) has 73% fewer homes available for sale than pre-pandemic, 57% fewer weekly contracts, and an 8% increase in real estate listings. (Information about Altos research) As a result, prices have remained relatively stable due to the outperformance of the balance of buyers over sellers.

I see buyers today taking their payments step by step for various reasons. Their incomes have risen exponentially, by over 25-30% since 2020, and the income tax savings through the mortgage interest deduction are now a meaningful budget line item to consider. Many also say, “I can always refinance when rates go down in the future,” leading to the feeling that these higher payments won’t last long.

When I say buyers are comfortable with these payments, I know there are also 2-3 times more buyers who make payments with online calculators who choose not to participate in the conversations in the first place! To prove it, our pre-approval credit drawdown (a measure of buyer activity in the top funnel) is about 50% lower than before the pandemic.

Of the borrowers you work with, how high are the monthly payments? How do they react when you give them the number?

For the better part of the past decade, most of my clients have been getting into a pre-approval conversation with a maximum mortgage payment of no more than $3,000 for an apartment and $4,500 for single-family homes. It was rare to see numbers higher than that, even for high earners. Today, those numbers range from $4,000 to $6,500, respectively.

To my previous comment, today’s active buyers seem to be anticipating that. It’s as if they’re comfortable with this new normal. Surprisingly, debt-to-income ratios today (in my market) are very similar to what they were five years ago. Income is ultimately the great equalizer. Yes, payments are significantly higher today, but buyers’ residual income (income after taxes minus debt) is still in a healthy range because of local wages.

Remember, we’re still talking about a much smaller group of buyers in the market today, so this conversation is leaning toward those with more fortunate lifestyles.

Tell us a little bit more about what you saw in the second half of 2022 in the domestic housing market, and how does that compare to the first half of 2023?

There are significant differences between these two periods. In the second half of 2022, there was nothing but fear. The stock market was under stress, inflation was running rampant, and housing was starting to falter. Across the country, inventory is starting to run up, days on the market have skyrocketed, and price drops are rampant. The safest bet was to do nothing, and that’s exactly what the buyers did. The mentality was, “I’m going to wait for prices to go down and prices to go down before I buy.”

The start of 2023 caused a reversal in many asset classes. The stock market found its footing and pushed higher, mortgage rates rebalanced, real estate sellers adjusted their prices, and employers began paying hefty wage increases. As a result, housing has stabilized, and in some areas, aggressive contracts with multiple offers, price escalations, and emergency relief have become the norm.

The strength in housing hasn’t been as universal as it has been in 2021. There have been very hot and cold segments, depending on location and price point. It seems that the affordable segment (<750.000 دولار في السوق) والقطاع الأعلى (> $1.25 million) is doing very well with increasing competition. The mid-range segment is where we noticed some difficulties. One common theme is that buyers at each price point seem to be more sensitive to the condition of the property. When housing payments are that high, it won’t take much for buyers to walk away!

What do you think of the so-called “lock-in effect” – the idea that current market volatility will be constrained because people refuse to let go of double- and triple-handle mortgage rates?

I think the “lock effect” is very real. My opinion is based on countless conversations I’ve had in the last six or nine months with homeowners who want to move but can’t. Some cannot afford their current home with today’s value and price structure. Others cannot afford the large jump in payment to justify the increase in home size or preferred location.

I think the reason we’re seeing difficulties with a mid-range home is because the traditional move-up buyer is stuck. In the market I’m in, that would be the person who sells the $700,000 home to buy it for a million dollars. They currently have a PITI housing payment of $2,750; The new payment will be $6,000 for their equity as a down payment. This jump is too big for most people, especially those with an average income. That would have been $4,500 two years ago, which would have been much easier.

Based on what you’re seeing now, do you have any predictions for what the second half of 2023 might look like? And what about spring 2024?

Despite the high prices, the desire to buy a home remains high for many. Given the effects of the delayed Fed tightening (raising interest rates) along with the general improvement in inflation, one can assume that mortgage rates have crossed the top and will continue to improve from here. Think of playing with a yo-yo on a downward-moving ladder, an up-and-down motion but generally a downward push. As prices improve, so will affordability and trust, attracting more buyers and sellers.

I think this will be supportive of home values ​​and give buyers more choice as inventory increases. Keep in mind that most sellers become buyers, so the net effect on inventory will be minimal. Knowing that some sellers will keep their existing home as a rental, one could argue that the inventory will only get worse. Buyers will at least have more home choices each week, which is a stark difference from today.

When discussing strength in housing, thinking through local dynamics is crucial. The D.C. metro area has a diverse and stable job market that I don’t see reversing in the event of an economic downturn. We haven’t had a massive push into short term rentals as many other areas and the “work from home” (WFH) environment has had most people staying within walking distance of towns.

One thing I predict is WFH being dismantled in 2024. In fact, I’m already testing that. Many clients are called back into the office, either through employer requests or fear that they will be exposed to companies’ downsizing efforts. As a result, I expect underperforming assets (DC apartments and single-family rentals in transitional areas of the city) to gain exposure while single-family rents in mobile neighborhoods plateau from record appreciation over the past few years.

Housing market affordability (or better yet, the lack thereof) has reached levels not seen since the height of the housing bubble. Do you have any advice on how potential buyers can ease this burden?

This may be the most complicated question as everyone is in a different place in life. For the better part of the past 20 years, my counseling calls have been 20-30 minutes long, and we can craft a great plan. Today, that takes over an hour and usually requires a detailed follow-up call. If I had to sum up all my talks, I’d say it’s a matter of foresight and patience.

Forecasting is a process in which life is determined over the next two or three years – discussing job stability, income expectations, saving and investment patterns, debt flowing in (or being added up), children, schools, tuition fees, and so on. This helps in creating a solid budget to use for the purchase of a home.

Patience can mean several things. For some, that means renting for a period of time to save more money or get rid of periods of uncertainty. For others, it could be looking for the combination of the right selling price and seller perks to lower prices, closing costs, and so on. Maybe you can’t own that particular home in that particular area for a few years and settling for the next best location is good enough for the time being. Housing used to be a go-to for many, but the low-priced environment of the past few years has allowed everyone to get what they want right away. We seem to have lost the art of patience in life.