Why is the housing market so expensive?

Why are homes so expensive? A variety of factors have contributed to higher sale prices, including interest rates, low inventory and inflation. Here’s more about market conditions and which outside influences affect home prices, plus tips on how to become a homeowner without breaking the bank.

Historical home values

Data over the past few years show that home prices have rocketed ever higher. June 2022 saw the highest median sale price NAR has ever recorded at $413,800, and June of this year was not far off at around $410,000. It’s no surprise that many hopeful buyers, and especially first-time buyers, are being pushed to the sidelines in an affordability crunch.

“Homebuyers today are spending about 33 percent of their income to become homeowners,” says Clare Trapasso, executive news editor for Realtor.com. “That’s about double what they spent in 2012 and 2013, when the nation was coming out of the Great Recession.”

Consider that NAR’s median home price was only $280,700 in March 2020, just as the pandemic began. The steep climb since then has been remarkable, and a myriad of factors have contributed to the affordability predicament the market is in now.

Supply and demand

A well-balanced real estate market that doesn’t tilt in favor of either buyers or sellers requires 5 to 6 months of housing supply. However, as of July the country has only about 3.3 months’ worth. This is an improvement from January’s record low of 1.6 months, but it still falls significantly below the equilibrium point. There just isn’t enough supply in the pipeline to satisfy buyer demand.

“The nation is in a severe housing shortage,” Trapasso says. “Builders can’t put homes up fast enough, and they are constrained by high construction costs.”

Sean Roberts, CEO of Villa Homes, agrees. “Housing has been materially under-built for the past 15 years, especially entry-level homes,” he says. “New home construction has been focused primarily on larger and higher-priced homes, with very few entry-level, affordable residences prioritized. The lack of housing inventory has resulted in stark competition and driven prices to an all-time high and affordability to a multi-decade low.”

House payment on 3.5% vs. 7% home loan rate

Another culprit? Mortgage interest rates, which have climbed quickly and significantly, making it harder than ever to afford a home purchase. The average rate for a 30-year mortgage was 7.36 percent as of August 23, according to Bankrate’s weekly national survey of large lenders. That’s the highest it’s been in more than 20 years. By comparison, at the end of August 2022 it was just 5.78 percent, and at the same time in 2021 it was a quaint-seeming 3.04 percent.

“Higher mortgage rates are making monthly house payments even more expensive,” Trapasso says. “Mortgage payments were up 96 percent from June 2019 to June 2023.”

For over a decade, low interest rates were a key factor in fueling demand and making many larger new homes relatively affordable, Roberts says. “But the rapid rise in mortgage rates has created a so-called ‘lock-in effect’ that has stalled many families who would have otherwise considered moving. Homeowners who locked in a mortgage rate of 3 percent to 4 percent during the pandemic are now unwilling to purchase a next home at a 6 to 7 percent rate, which means even fewer homes are going on the market, as existing homeowners choose to stay put.”

To demonstrate how higher rates have iced out many buyer prospects, consider this scenario: Let’s say you bought a $400,000 home for which you took out a $320,000 mortgage loan (after putting down 20 percent) at a 3.5 percent fixed rate over 30 years. Your monthly principal and interest payment at that rate would be only $1,436. If you bought the same house with the same loan at a 7 percent interest rate, your monthly payment for principal and interest would be $2,128. That’s a huge $692 more every month, or $8,304 extra per year.

Wage and inflation growth vs. home-value growth

Another reason why homes are less affordable nowadays has to do with average wage growth versus home-value growth. When home prices rise faster than a buyer’s income does, homeownership gets further out of reach. High inflation makes matters even more difficult.

“While wages and inflation have been growing, home values have been rising at a faster pace in many areas, making it difficult for some buyers to keep up with the increasing prices,” says Aaron Bowman, an agent with Real in Connecticut.

Fortunately, average weekly earnings are on the rise — increasing between 3.4 and 3.8 percent year-over-year in May, June and July 2023, according to the U.S. Bureau of Labor Statistics — and inflation has dropped significantly since its peak in June 2022. But many people’s earnings still can’t keep up with the rapid pace of home prices.

Ways to get a less expensive home

While all of these signs point to a challenging environment for house-hunters, it doesn’t mean that affording a home is impossible. These expert tips can help make you a homeowner without spending quite so much:

• Compromise on size: Don’t think big — you need a home but not necessarily a mansion. “Think about purchasing a smaller home, such as a condo, townhouse or single-family home with less square footage,” says Trapasso.
• Broaden your search range: You get more for your money in some locations than others. “Consider moving farther out from the larger cities to cheaper areas and places with lower property taxes,” Trapasso adds.
• Consider a fixer-upper: An older home in need of upgrades is usually cheaper. This can score you a great deal, especially if you are handy and can perform some of the improvements yourself.
• Shop around for loans: Different lenders offer different rates and terms, so do some comparison shopping to find the best deal. Remember, too, that not all loans require a 20 percent down payment. “Borrowers should explore FHA loans, which may require just 3.5 percent down, as well as VA and USDA loans if they qualify,” Trapasso says.
• Look into buyer assistance programs: Check out down payment assistance programs to see if you qualify for financial help — these are designed to make homeownership more attainable, especially for first-time homebuyers.. “Investigate assistance programs and grants that can aid first-time buyers or those with limited financial resources,” says Bowman.
• Try purchasing with a partner: Think about recruiting a co-borrower and/or roommate who can help pay the mortgage, and build equity together.

Next steps

The housing market is tough for buyers right now, to be sure. But it’s not impossible if you’re financially prepared and willing to potentially make some compromises. Shopping around for the best rates and looking into all the assistance programs available in your area can help with affordability. And working with an experienced local real estate agent will ensure that you find the listings that best meet your needs, and your budget.

FAQs

• Will the housing market crash?

  Experts doubt that we are headed toward a housing market crash such as the one we experienced in 2008. There are more buyers than there are homes available, which is keeping home prices high. Additionally, lenders are much stricter now than they were before the Great Recession, which means borrowers are more qualified and less likely to default on their loan.
  

• Should I buy a house now or wait until 2024?

  The decision on whether to purchase a home now or hold off until a later date is a personal one that will depend on your unique financial position, job security, earnings and comfort level. Mortgage rates and home prices might be lower next year, but it’s impossible to perfectly time the market. Keep in mind that if you are financially able to purchase now, you can always refinance if mortgage rates drop in the future.
  

• Is it cheaper to build or buy a house?

  Your location has a lot to do with whether it’s cheaper to build or buy a house. Land and labor costs vary considerably throughout the nation, and in most areas, it will likely be less expensive to purchase an existing resale home. The median price of an existing home in July 2023, according to the National Association of Realtors, was $406,700. The price of purchasing land and hiring architects, builders, skilled labor and more can far exceed that, and also take much longer.