High Interest Rates Are Crushing First-Time Home Buyers
September 6, 2023
A Big Squeeze.
There's probably not a topic more discussed nor a metric more closely watched in the real estate market these days than the home mortgage interest rates. They are currently stuck in the mid-7% range for the 4th straight week, which makes it the longest stretch being over 7% in the last several decades.
If you talk to anyone who has owned a home here for a long time, 7% was once the “norm” for home mortgage rates, and they were even higher during gas crisis years of the late 1970's and early 80's. But home prices were also a fraction of what they are now.
So how do these kind of mortgage rates translate when you're talking about real-world monthly payments? What does a 7.58% mortgage really look like?
I created a typical scenario below of a first time buyer trying to purchase an entry level San Carlos home. And the numbers are pretty ghastly:
The True Cost of Living.
It's important to for potential buyers to understand that the “true” cost of owning a home is not just what you owe the bank each month. We commonly use the acronym PITI to more accurately quantify the monthly cost of ownership, which is the Principal + Interest + Tax + Insurance.
The average price for a home in San Carlos still runs about $2,000,000 so we'll use that as our example price. Since these are first time buyers, we'll assume they are “only” coming in with the minimum 20% down payment. I emphasized “only” because that 20% translates into $400,000 of cash. That's a big chunk of change for a first-time home buyer to save up!
That means our fictitious buyers are borrowing 80% of the $2,000,000 purchase price from a bank. In this example, we're going to use the prevailing rate or 7.58% for a 30-year fixed loan. Of course, this figure may vary slightly with other loan options such as Adjustable Rate Mortgages (ARMs) or interest only options. But this serves as a good example to drive my point home.
The figure for property taxes and the assorted assessments that are levied in San Carlos runs approximately 1.25% of the purchase price annually, and we'll use a figure of $1,500 per year for fire insurance (note it will be MUCH higher if you're buying in a high-fire hazard zone.)
So when we crunch these numbers together, what is the true monthly payment (PITI) for a $2,000,000 home in San Carlos with 20% down?
$13,525/month, or $162,300 annually.
Pretty ghastly, huh?
What Kind of Income Do You Need?
While home ownership is still one of the single largest tax deductions that one can claim, recent changes to the tax code have dramatically curtailed how much mortgage interest an owner can write off especially in high cost of living states like California, and calculating the exact write off is way beyond the scope of this post.
For the sake of our discussion, let's assume our buyers fall into the combined Federal and State percentage of 45% — not the top bracket, but pretty close.
So in order to cover the PITI for this home, the new owners will have to dedicate approximately $249,692 of their gross income just to cover the basic cost of the home (prior to accounting for tax write-offs). This doesn't account for any repairs, improvements, or even utilities. It's just the cost of having a roof over their heads that they can call their own.
It's exactly that kind of boulder that is crushing many first-time home buyers in today's market.