By: Liz Strait, PhD
Introduction
The current economic environment, particularly the residential housing market, is reshaping personal finance decisions and life plans for numerous individuals. For many Americans, owning a home is the definition of personal financial success. Yet, recent trends related to home prices and mortgage rates have made that milestone harder, if not impossible, to reach. As a result, many potential homebuyers are redefining their financial goals and reallocating their income and savings as a result. These changing goal posts are important for Financial Professionals (FPs) to understand, as are any biases that may lead to suboptimal financial decisions because of this shifting landscape.
In a previous blog post, I discussed increasing borrowing costs and gridlock in the residential housing market. This post is a follow-up to that but focuses instead on how spending and savings patterns have changed in the face of increasingly inaccessible housing prospects.
Client Impacts
Recently, we have seen the following trends in the residential housing market among US consumers:
- A Shift in Home-Buying. Due to the combination of soaring mortgage rates and record-high average home prices, many potential home buyers are giving up on the housing market. As a result, from September 2022 to September 2023, there has been a 15.4% decrease in existing home sales.1 What’s unique about the current situation is that usually higher mortgage rates are compensated for by lower home prices. However, as the data shown below illustrates, median home prices increased from January 2021 to January 2023 despite a 3.83 percentage point increase in mortgage rates during that same time.
Source: FRED Economic Data via the St. Louis Federal Reserve Bank (MSPUS and MORTGAGE30US data series). Median home prices were adjusted to October 2023 dollars using the Bureau of Labor Statistics (BLS) CPI Inflation Calculator.
- Relying on Renting. Those who find it challenging to buy a home are postponing their plans, not just for months but for years. Many have accepted a future wherein they are renting rather than owning. In fact, according to The Economist, for 89%of Americans it is more cost-effective to rent a two-bedroom property than to buy it.2 In 2020 this was only true for 16% of the population.3 Further, Bank of America found that renting is cheaper in all but 2 of the 97 major metropolitan areas in the US.4
- Investment Reallocation. Many of those now priced out of the housing market, have started redirecting their savings to other areas. There has also been an increase in consumer spending as these individuals use the money they had saved to buy a house for things like vacations or other experiences.
- Market Gridlock. As market conditions make it increasingly difficult to upgrade to bigger or better homes, many current homeowners are stuck in starter homes and believe they will be for quite some time. As a result, some are choosing to renovate their current properties instead of moving—many relying on home equity to do so.
- Changing Perceptions of Success. The unaffordability of the housing market is leading people to redefine personal success, moving away from traditional milestones like homeownership. As a result, many individuals are changing their financial plans and aspirations.
Larger Economic Impacts
The housing market's health is intricately tied to the overall economy, so changes can cascade through various sectors and have long-term economic implications—regardless of whether any specific individual is facing the difficulties described above.
- Wealth and Investment. Homeownership is a primary source of wealth accumulation for many. Changes in housing trends could affect wealth distribution, with potential impacts on savings rates and investment patterns. These changes could influence stock markets and retirement planning.
- Inequality Concerns. Related to the above, prolonged difficulties in home buying can exacerbate wealth and income inequality, as property ownership is a key component of net worth for many households. This can have broader social and economic implications—for example, income inequality has been shown to have a direct and significant impact on the happiness of a nation.
- Banking and Finance. The housing market influences the banking sector, particularly through mortgage lending, refinancing, and related financial products. A downturn in new mortgage originations could affect the profitability of banks.
- Monetary Policy Implications. Central banks closely monitor the housing market as both an indicator and driver of economic health. Changes in housing trends can influence decisions regarding interest rates, which have wide-reaching effects on the economy.
- Investor Behavior. Real estate often acts as an investment vehicle. Shifts in the housing market can affect real estate investment trusts (REITs), housing stocks, and other related investment products, influencing investor behavior and market dynamics as a result.
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End Notes
[1] According to the National Association of Realtors: https://www.nar.realtor/research-and-statistics/housing-statistics/existing-home-sales.
[2] The Economist. “Is It Cheaper to Rent or Buy Property?” 30 Nov 2023, https://www.economist.com/united-states/2023/11/30/is-it-cheaper-to-rent-or-buy-property. At this link, there is a fascinating graphic that visually demonstrates where it is cheaper to rent vs. buy a property in the US for 2020 and 2023. The drastic changes in the map are almost unbelievable.
[3] The Economist. “Is It Cheaper to Rent or Buy Property?” 30 Nov 2023, https://www.economist.com/united-states/2023/11/30/is-it-cheaper-to-rent-or-buy-property.
[4] Botros, Alena, and Nick Lichtenberg. “Should You Buy or Rent a Home Right Now? Bank of America Says Rent.” Fortune, 25 Nov 2023, https://fortune.com/2023/11/25/is-it-better-to-buy-rent-home-housing-market-bofa/.
[5] See: (1) Sharif, M. A., & Shu, S. B. (2017). The Benefits of Emergency Reserves: Greater Preference and Persistence for Goals that Have Slack with a Cost. Journal of Marketing Research, 54(3), 495-509. https://doi.org/10.1509/jmr.15.0231 and (2) Sharif, M.A., and Shu, S.B. (2021). Nudging persistence after failure through emergency reserves. Organizational Behavior and Human Decision Processes, 163(1), 17-29. https://doi.org/10.1016/j.obhdp.2019.01.004.
[6] Of course, individuals should be compensated for waiting as waiting does entail uncertainty. Additionally, if the rate of return on waiting is less than the interest rate, one should not wait.
[7] Wolfe, Rachel. “Buying a House Isn’t Happening, So They’re Spending and Saving Differently.” The Wall Street Journal, 10 Nov 2023, https://www.wsj.com/personal-finance/mortgage-home-buying-rent-down-payment-41308669.
[8] See: (1) Hershfield, H. E., Goldstein, D. G., Sharpe, W. F., Fox, J., Yeykelis, L., Carstensen, L. L., & Bailenson, J. N. (2011). Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self. Journal of Marketing Research, 48 (SPL), S23-S37. https://doi.org/10.1509/jmkr.48.SPL.S23. (2) Hershfield, Hal. Your Future Self: How to Make Tomorrow Better Today. Little, Brown Spark, 2023.