Bee | High IQ Buying: Buying A Home During A Recession
January 12, 2023
Buying A Home During A Recession
All we hear right now is recession, recession, recession that's certainly going to happen this year. And while previous recessions have caught everyone by surprise because nobody thinks the music will end, it seems as if everyone and their mother is expecting one in 2023.
Before we explore the unique advantages a recession gives home buyers, let’s first understand what a recession is and why it’s not so bad for an economy.
What is a recession
Although the definition is open to academic interpretation and political opinion, the classic definition is that a recession is consecutive quarters of negative GDP growth. In other words, the economy contracts two quarters in a row.
In the broader sense of the market, this is good and needed. No markets can go up forever just as they can’t go down forever [hopefully]. Think of a recession as pruning a tree so that it has the chance to grow higher. Without a natural pull back, fair value is overtaken by irrational exuberance, which isn’t good for anyone.
Just think about the last time when you were irrationally exuberant–the end of the bachelorette party you can’t remember, or the company holiday party where you might have had a few too many and found yourself making out with someone on a table like your plane was going down. Regardless, irrational exuberance is not good under any circumstance which is why recessions are natural and needed for healthy markets before they take the next leg up.
The biggest contributor to a recession is the Fed's policies for their benchmark, or federal funds, interest rate. The higher it is, the more costly credit becomes. This impacts businesses ability to obtain financing to fund growth. The higher and longer the Fed raises rates, the more severe an inevitable recession becomes. At some point the cost of credit will cause contractions in the economy, thus leading to a recession, or consecutive periods of negative growth.
Now that we've emerged from the pandemic, we're truly in uncharted territory with rates, employment, and the economy at a whole. Some of the old metrics and data sets that would mean one thing don't any more. There are millions of jobs to fill and if unemployment remains low, the Fed will continue to raise rates until inflation is nearing their 2% target. If this happens mortgage rates will not fall that much during a recession.
The December CPI (consumer price index) report just came out and inflation is up 6.5% from this month last year, and while the index continues its downward trend, it's still a lot higher than the Fed's 2% target.
One thing is certain, the Fed has been steadfast in its commitment to raise rates until inflation is under control - even if it means breaking the economy to stop hyper-inflation. And they deserve credit for doing so despite the criticism. Hyper-inflation is a lot like going bankrupt, which happens slowly at first then all of a sudden. Once it sets in there's no stopping it.
How does a recession impact home buying
Home prices tend to drop during a recession due to an increase in inventory caused in part by more foreclosures as people lose their jobs and ability to keep their homes. Home prices dropped $65,100 on average in the crash of ‘08, but there's no guarantee they'll drop that much as certain markets hold up better than others, especially Florida where a lot of people are moving to each year (about 900 people per day).
If you have the opportunity, buying when prices have dropped is the best move to make. Unlike buying when rates are low and prices are high, buying when home values have dropped allows you to refinance a lower principle balance when rates drop. You don't have that opportunity if you buy when home values are high but rates are low. You're still stuck and a higher loan amount. As we dig into detail with High IQ Buying here, no matter where prices are in the market, it's always a good idea to strategically negotiate with the seller to get the best deal you can.
Historically, during a recession mortgage rates tend to drop as the Fed lowers interest rates to stimulate the economy by making credit easier to obtain. However, there is no guarantee we’ll see the same historic low mortgage rates like we did in 2020 & 2021. Those rates originated from the pandemic, possibly a once in a century type event. It's rare to see lenders hitting premium capacity, meaning rates can't go any lower, and have nowhere to go but up. If you locked in a rate back then, congratulations, don't touch it.
30 Year fixed mortgage rates over the past 5 years
Warren Buffett once said to be “fearful when others are greedy, and greedy when others are fearful.” Buying a home during a recession is the ultimate move when others are fearful. During recessions, things go on sale that would otherwise not be on sale. This includes stocks and property.
Recessions can give you unique buying opportunities that might not be around if the market was good.
There's no telling what motivates someone to sell their home, but when jobs are being lost and retirement accounts are getting hit, sellers could be in a tight spot needing to sell the home fast. Again, this is why we highly recommend researching the seller's motivations in this High IQ Buying blog post, in addition to other important things to remember when making an offer on a home.
Sellers tend to give more seller concessions the longer the home sits on the market, making it cheaper for you to buy. Seller concessions are credits towards closing costs and can usually be as high as 9% of the loan amount if your down payment is 25% or more. This can add up to a lot of money you save. Some mortgage companies, such as Bee, offer rate buy-downs, which give you a lower rate for the initial year or so saving you a lot of money if rates are high. These programs are for a limited time only though so check availability.
You might also be able to find deals on short sales or homes in foreclosure. But be careful, some of these houses can cause you to incur additional costs so make sure you have the home properly inspected so you know what you're buying. Even after an inspection, you might still be required to buy the home as-is so the seller or bank would not be giving you any money towards things that need to be repaired. This can impact your home warranty, ongoing maintenance costs, and homeowners insurance costs.
With a long term view, over time you'll be okay, no matter when you buy. This chart from the Federal Reserve will give you an idea of how the housing market has performed during recessions. The gray bars are recessions, and, as you can see, home prices held up pretty well historically.
When to buy
The bottom line is that recessions shouldn't scare you off. You actually get a better deal on how much you'll pay back to the bank by starting out with a lower loan amount and refinancing quickly into a lower rates when they drop. No one can predict the market, but no matter when you buy, you'll probably end up in the green over a long period of time as homevalues appreciate overall. And while home prices historically have dropped during a recession, waiting to catch the bottom of the market can drive you nuts, causing you to put your comfort and peace of mind on hold while you try to catch a falling knife. So, if you’re waiting for the perfect market conditions of low rates and home prices, you might be waiting a long time because that’s not how the market works.
If rates drop, home prices tend to go up. If rates go up, prices tend to drop. There's no perfect market conditions for when you should buy. Again, you buy when you're ready to buy, when you can afford it, and when you've found your dream home. If rates drop after you buy, refinance into a lower rate and payment. If they don’t, be thankful you locked in a low rate when you bought the house.
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