For more than a year, the Federal Reserve has been struggling to tame inflation with a seemingly endless series of interest rate increases. Yet the U.S. economy roars on.
Many sectors are still experiencing robust job growth, while consumer spending remains strong. That’s why economists think the Fed will continue its rate-cutting strategy until inflation is finally vanquished.
Though the Fed has had limited success in slowing inflation, higher mortgage rates have meant a gut punch for would-be homebuyers, because every jump in mortgage rates reduces the buying power of wannabe owners.
Still, many buyers, including those who’ve long lived in rental housing, are pushing on with their purchase plans.
“No one wants to bury their homeownership dreams, no matter how discouraged they are with the mortgage pricing situation,” says Keith Gumbinger, a vice president at HSH Associates (hsh.com), which tracks mortgage markets across the country.
Ironically, he says those with well-paying jobs may be technically entitled to borrow more than they can truly afford. Even now, with tight lending standards, people who have professional livelihoods and strong credit scores can take on more mortgage debt than would be prudent.
“It’s very possible to put yourself behind the eight ball when you finance a house,” Gumbinger says.
Of course, as always, there are many potential buyers who must struggle to gain approval for a home loan of any size. These include self-employed people and those with blemished credit reports.
Yet at the same time, other borrowers are offered the chance to take out a larger mortgage than is wise in their case, says Sean Sebold, a veteran financial planner.
“There are lots of reasons to be conservative on how much you spend for a house. One factor is that if you overbuy and can’t afford it, you’ll be hit with major transaction costs to sell your home and buy a smaller one,” says Sebold, who’s advised clients since 1994.
Among the buyers who should be especially careful not to overspend are single people and couples supporting a household on just one income, he says.
How is it possible to borrow more than is wise for a home purchase?
The explanation is that lenders don’t know everything about their borrowers’ living costs. For example, buyers seeking a mortgage needn’t disclose that they face high costs for their toddler’s day care or that they’re helping cover a father’s nursing home bills.
“The lender is blind to everything but the income and liabilities on your record,” says Sebold, who’s affiliated with the National Association of Personal Financial Advisors (napfa.org).
Granted, many people are now more attentive to inflation than before the pandemic. But Sebold says some financially stretched buyers are still willing to borrow up to the ceiling set by their lenders -- on the assumption they’ll cut their discretionary expenses later.
“The problem is most people don’t actually reduce their spending the way they expected to after moving to their new house. They keep spending as much as ever on restaurant meals, travel and expensive hobbies,” he says.
Why do buyers continue to spend more than planned --even after taking on a big mortgage? Sebold believes most Americans are inherently optimistic about their finances.
Here are a few pointers for buyers:
-- Avoid mortgage brokers who push hard for your business.
With the run-up in interest rates, the home loan industry has gone through a major contraction in employment. That’s because mortgage demand, including from those attempting to refinance their loans, has dropped off dramatically.
Although there are fewer people working in mortgage lending, those still in the field are now competing as aggressively as ever for loans, Gumbinger says, and many work on commission, meaning they don’t get paid unless their deals go through.
“Brokers are absolutely hungry for business,” he says.
-- Review your finances prior to taking out a mortgage.
Sebold suggests that before looking at property, you do a careful analysis of your income and outflows to ensure you’ll have adequate funds to cover both your mortgage payments and your nonhousing expenses.
Because reducing your expenses could be even harder than reducing your weight, Sebold advises that the best way to determine how much you can afford for housing is to examine your spending over a recent three-month period. Then assume you’ll spend as much or more after you buy a home, adding in extra costs for the property, such as for hardware and garden supplies.
-- Establish an upper limit on how much you’ll spend for a home.
Are you working in a field with high levels of unemployment -- such as at a tech firm that’s doing a lot of layoffs? If so, Sebold says you should keep regular contributions to savings in mind when calculating how much you can afford to put into housing.
“If you’re working in an insecure job, you’d better have a year’s worth of living costs set aside if you’re in a one-income household,” he says.
Even if your household has two incomes -- and you believe both parties’ jobs are secure -- Sebold says you’ll want to add in a financial buffer when calculating what you can afford for housing.
After gaining mortgage preapproval, he urges you to set a firm upper limit on how much you’ll spend before heading out to look at property. Put this number on an index card and carry it in your pocket when you’re searching for the right home, he says.
“You should always know that number before going out to buy,” he says.
(To contact Ellen James Martin, email her at email@example.com.)