Should Young Adults Stretch Financially to Buy a Home?

But the supply of homes is tight, and new construction can’t keep up with demand—which means that buyers often have to fork over a staggering amount to close a deal. U.S. house prices soared 12.2% in February from a year earlier, the biggest annual increase in data going back to 1991, according to the Federal Housing Finance Agency.

For millennials who are looking for a home, this means a tough calculation. Many of them have limited funds and are carrying a lot of debt. So, is it worth stretching their resources to buy a more expensive house if they can lock in a lower mortgage rate for years to come?

Or should they wait until housing prices cool down to more affordable levels—and risk having mortgage rates rise in the meantime? Already, rates recently hit their highest level since June, and many economists expect them to continue creeping upward this year.

Debating the issue are Susan Wachter, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, and Laurie Goodman, vice president for housing finance policy and the founder of the Housing Finance Policy Center at the Urban Institute.

YES: Interest rates are low and housing prices are unlikely to come down

By Laurie Goodman

Interest rates are at near-historic lows. There have been only eight months in the past 50 years when rates were lower than they are now—and those eight months were all during the pandemic.

That is why this is an ideal time for young people to stretch themselves financially to buy a home.

While home prices have increased dramatically over the past year, and might seem high by historical standards, they’re unlikely to come down, as houses are in short supply. Interest rates, meanwhile, are likely to rise.

Young people who want to become homeowners should take advantage of the situation to lock in their mortgage payments for the next 30 years, essentially inflation-proofing their housing costs. Having a stable housing situation is crucial. Landlords can raise the rent to an unaffordable level or refuse to renew the lease for any number of reasons. If young people remain renters, they can expect their housing costs to go up each year, perhaps faster than the rate of inflation, especially given the tight housing supply. Even if a mortgage payment is a stretch for young people today, they will grow into the payment, as their income is likely to rise over time.

There’s another crucial advantage to homeownership: It remains the best way to build long-term wealth. Even though many young people saw their parents go through the great financial crisis, with home values down 25% from the 2006 peak to the trough in 2012, home values are up 73% since the 2012 lows and are 29% above the previous peak, according to Urban Institute calculations based on data from mortgage-technology and data firm Black Knight. Bidding wars are erupting in many markets because of low supply.

Rising Values

Some argue that the current appreciation rate in home values is unsustainable. But the housing-supply shortage and production of new units that is low by historical standards suggest that values will continue to rise. And even if the rate of appreciation slackens, home buyers can still see strong returns on their investment.

New borrowers, on average, put down about 5% of the home’s cost, financing the balance with a mortgage. If the borrower puts down 5%, or $10,000, on a $200,000 home, and the home increases a modest 3% annually, the home would be worth $231,854 after five years. The five-year return on the borrower’s $10,000 investment is 316%—a figure that you’re unlikely to get with a $10,000 stock-market investment. The earlier a young person can stretch to access homeownership, the more time they will have to accrue the benefits of this leveraged investment.

Lower debt

Of course, homeownership isn’t the best option for everyone. There are transaction costs, in the range of about 8%—5% for buying and selling the home and 3% for various mortgage closing costs and expenses. This suggests homeownership isn’t ideal for people who intend to move within a year or two, as the transaction costs outweigh the wealth-building benefits. But geographic mobility has been declining, with millennials moving less often than their parents did at the same age.

Some may also say that we’re heading for a debt bubble—a big driver of the last housing collapse. But mortgage debt is way down right now, and other debt is nowhere near the levels it was before the 2007-09 recession.

Finally, critics bring up a potentially huge downside to buying a home: If a financial crisis hits and you get laid off, you might miss your mortgage payments and stand to lose your house. But even if you do lose your job, you’re not stuck. In most recessions, home prices don’t decline—so you will likely be able to sell your home without taking a loss and downsize to a less-expensive one.

Bottom line: If a young person interested in homeownership has the opportunity to buy a home in this low-interest-rate environment, they should do so. There is no guarantee that interest rates will stay this low for long, and the earlier homeowners start building equity, the better.