Calling All Homebuyers: How To Navigate A Tough Real Estate Market

Buying a house is an exciting milestone, but it can also be financially daunting. In today’s market it is particularly challenging with a perfect storm of low inventory, fierce competition, and the highest interest rates in decades. When the Federal Reserve decides to cut interest rates, monthly payments will become more affordable, but in the meantime all is not lost. Potential homebuyers do have some strategies available for interest rate reductions, so let’s explore the options here.

  1. Buy Down Your Rate with Points
  • You can lower your interest rate by paying for discount points upfront. Each discount point costs 1% of the loan amount.
  • Suppose you’re borrowing $600,000. Paying $6,000 for one discount point would typically lower your interest rate by 25 basis points (0.25%).
  • To calculate your breakeven point, divide your buydown cost by the monthly savings. For example, if paying $6,000 for one discount point saves you $100 per month on your mortgage payment, your breakeven point would be approximately 60 months (5 years). You’d need to remain in the home for at least that long to recoup your buydown cost and see real savings on your loan.
  1. Consider an Adjustable-Rate Mortgage (ARM)
  • An ARM offers an initial low introductory rate, typically fixed for the first few years (e.g., 3, 5, 7, or 10 years) of a 30-year loan.
  • While the initial rate is lower, be cautious as the rate may increase later based on market conditions. However, if you are considering refinancing or selling before the fixed term is up then this could make sense.
  1. Opt for a Shorter Loan Term
  • Choose a shorter loan term (e.g., 15 years instead of 30). Shorter terms often come with lower interest rates. While your monthly payments may be higher, you’ll pay significantly less interest over the life of the loan.
  1. Make a Larger Down Payment
  • A substantial down payment reduces the loan amount, leading to a lower interest rate. For example, if you’re buying a $800,000 home, putting down 25% ($200,000) instead of 20% ($160,000) will result in a smaller loan balance and potentially a better rate.
  • Benefits of a larger down payment also include a smaller home loan balance that creates a cushion of home equity even if market values decline, and no private mortgage insurance (PMI). Borrowers who put down 20% or more avoid PMI, which can add to monthly costs.
  1. Make Lenders Compete
  • Obtain rate quotes from multiple lenders and compare the terms of their offers. Since rates have risen, the number of people buying and refinancing has dropped sharply. So lenders are eager for business and may be willing to match or beat competitors’ rates to win your business.
  1. Plan for Refinancing Opportunities
  • When the Federal Reserve cuts rates, we will see favorable refinancing conditions, so be ready to act when rates decrease enough to make it worth it to refinance.

While today’s rates are hovering just above 7%, keep in mind that in October 1981 the average 30-year fixed mortgage rate was a staggering 18.5%. So while today’s rates are considerably higher than they were a few years ago, homebuyers in the 1980s faced much steeper costs. Along with evaluating financing options, negotiating with lenders, and monitoring refinancing options, this historical context may make it feel more reasonable to seize an opportunity when it comes your way.

Breaking the Home Equity Piggybank

For the vast majority of people “home sweet home” is their most valuable asset. Borrowing against a home can free up cash for many purposes that would otherwise be out of reach. Enter home equity loans and home equity lines of credit (HELOCs), both ways to access home equity without the homeowner having to sell. Home equity loans and HELOCs are essentially second mortgages that are secured by the home as collateral.

To calculate equity, subtract the amount you owe on your mortgage from your current property value. Generally, lenders will let you borrow up to 85% of your home equity, depending on your credit score and history, employment history, and monthly income and monthly debts. However, if you default on payments for either a home equity loan or a HELOC, the lender can foreclose on the property. That said, tapping into your home equity can be a sound strategy to raise cash for large purchases if and when you need it.

The rundown on home equity loans:

  • Lump sum
  • Fixed interest rate
  • Conventional loan structure separated into interest and principal
  • Monthly payments are predictable and don’t change.
  • Monthly payments are for a set period.
  • Monthly payments are made in addition to mortgage payments.

The rundown on home equity lines of credit:

  • Revolving credit line, money is withdrawn as needed (like a credit card).
  • Variable interest rate often begins at lower rate than home equity loans.
  • Conventional loan structure separated into interest and principal or interest-only payments
  • Monthly payments adjust up or down based on a benchmark interest rate.
  • Rising interest rates can increase payment.
  • You only pay interest on the money you withdraw, not the total credit available.
  • Some lenders allow partial or full conversion to fixed rate home equity loans.
  • The typical borrowing period is 10 years followed by a repayment period of 10 or 20 years.
  • During the borrowing period, you have to make minimum monthly payments on the amount you owe..
  • Once the borrowing period ends, you have to repay the remaining balance, like a conventional loan..
  • Interest may be tax-deductible.
  • You can make additional principal payments.
  • You can refinance.

Which option is right for you? Home equity loans could potentially be better for people who have an upcoming one-time expense with a known cost. For example, this might include home improvement projects, a down payment on another property, wedding expenses, emergency expenses, even credit card debt consolation. Home equity loans could also benefit people who want to avoid overspending. On the other hand, HELOCs could potentially be better for people who have upcoming variable or periodic expenses and would benefit from access to a revolving line of credit. For example, this might include home improvement projects, college expenses, medical bills, long-term care expenses, or a new business venture. As with most financial planning questions, the answer to this question depends on each homeowner’s unique circumstances, so this is a great question to discuss with a financial advisor.

The Ongoing Property Tax Debate – California’s Proposition 5

Election season is fast approaching and eleven propositions are on the California ballot. The perennial challenge is to find the time to learn enough about each one to make informed choices, so I hope that providing a historical context for Proposition 5, currently on the ballot, is useful. Proposition 5 addresses the transfer of a home’s taxable value, in a long line of predecessor propositions addressing this same issue. Here is a brief survey of the related propositions, each of which amended the well-known and hotly-debated Proposition 13 to change who can transfer their home’s taxable value and how the transfers work.

Proposition 13 (1978): Decreased property taxes by using 1976 assessed property values, set tax rates at 1% of a property’s sale price, and capped annual increases at no more than 2%. Reassessment of a new base year value was prohibited except in the case of a change in ownership or the completion of new construction.

Proposition 58 (1986): Allowed the transfer of a primary residence between spouses or between parents and children without a reset on the home’s taxable value. In other words, the recipient of a house, whether a spouse or a child, would continue to pay the taxable value based on the limit set following the 1976 tax assessment.

Proposition 60 (1986): Allowed homeowners age 55 or older to transfer the taxable value of their present home to a replacement home, assuming the replacement home was of equal or lesser value, located within the same county, and purchased within two years of selling the original home.

Proposition 90 (1988): Allowed homeowners age 55 or older to transfer the taxable value of their present home to a replacement home in another county, but only if the county in which the replacement home is located agrees to participate in the program.

Proposition 193 (1996): Extended Proposition 58 by allowing grandparents to transfer their primary residence to their grandchildren without a reset on the home’s taxable value, when both parents of the grandchildren are deceased.

Proposition 5 (2018): Extends Propositions 60 and 90 by allowing homeowners age 55 or older, severely disabled, or who have contaminated or disaster-destroyed property, to transfer the taxable value of their present home to a replacement home, no matter the value of the replacement home, its location, or how many times the buyer has moved. The difference in market value between the present and replacement home would adjust the taxable value upward if the replacement home is worth more than the present home and downward if the replacement home is worth less than the present home. From Ballotpedia, the calculations are as follows:

Upward adjustment: (taxable value of present home) + [(replacement home’s market value) – (present home’s market value)]

Example: An individual sold her house for $500,000. The house had a taxable value of $75,000. She bought a replacement house for $800,000. The taxable value of the replacement house would be ($75,000) + [($800,000) – ($500,000)] = $375,000.

Downward adjustment: (taxable value of present home) × [(replacement home’s market value) ÷ (present home’s market value)]

Example: An individual sold his house for $500,000. The house had a taxable value of $75,000. He bought a replacement house for $300,000. The taxable value of the replacement house would be ($75,000) × [($300,000) ÷ ($500,000)] = $45,000.

It is once again up to the voter to decide if this is a ballot initiative that will continue to ease the homeowner’s tax burden and promote a culture of homeownership, or if it will continue to build up the tax disparity between older homeowners who pay lower tax rates and are disincentivized to move, and younger renters who want to buy but can’t afford the cost of entry at higher tax rates and suffer from a housing shortage. Affecting both sides, Californians are some of the most highly taxed people in the country, and the loss of revenue created by lower property taxes has resulted in higher taxes everywhere else.