Real estate is hot! How financial professionals can respond

A real estate boom swept across the nation in the wake of the COVID-19 pandemic, and has continued far longer than many anticipated. Early on, it was easy to understand the influx of homebuyers on the market, especially when families were stuck at home staring at the same four walls for months and there were historically low interest rates.

But what about now? 

The average 30-year fixed-rate mortgage topped 7% in late summer 2023, and while it pales in comparison to the 18% interest rates seen in the early 1980s, it’s still higher than we’ve seen in years.1 Add to that the rising cost of housing; the average price of a new residential home topped $500,000.2 

Ideally, any major financial decision should be made under the counsel of a financial professional. And a home purchase — whether building new or purchasing an existing home — is arguably one of the most significant financial decisions a person may make in their lifetime. 

The housing market is hot, but not everyone enters it with eyes wide open. Are you prepared to shed some light when clients come to you seeking advice? Help them move forward with a deeper understanding of how the decision could impact the future by making sure you address the following issues.

Duration of stay

In general, the longer someone stays in their home, the more equity they’ll build, and the more potential there is for their investment to grow. Choosing to stay in a home for only a short time may result in a negative financial impact. 

In particular, closing costs such as appraisal fees, title insurance, processing expenses and other costs can add a significant amount to the final price tag of a home, generally between 3–4%.3 For a $500,000 home, that’s as much as $20,000 that will need to be covered up front. That’s in addition to any earnest money or down payment.

It’s important for a homebuyer to consider how long it will take to break even or recoup those costs. It has the potential to take a few years, possibly longer if your client bought when housing prices were high. Do they intend on staying in the home that long?

Full cost of ownership

Of course, working with your client to determine their ability to comfortably afford the monthly mortgage payment is a part of basic home buying 101. But it’s all too easy for an eager homebuyer to overlook other expenses that could break the bank.

Make sure they’re taking the full cost of ownership into consideration and setting aside additional funds each month for these potential expenses so they have the money when they need it:

  • Homeowner association or condo association dues
  • Property taxes (likely escrowed into their mortgage)
  • Home insurance
  • Utilities
  • Replacing a broken furnace, appliances, leaky roof, etc.
  • General home improvements

Having an emergency fund is part of any good financial plan. When someone’s a homeowner, they may need to set aside even more than the average recommended amounts.

Potential for a downturn in the real estate market

There may be some trepidation among investors who witnessed the Great Recession and housing crash more than a decade ago. A lot of lessons were learned, and memories linger for many. The quick rise in today’s housing market may feel eerily familiar. 

There is no crystal ball to tell whether the current housing market will remain strong or soften in coming years. That’s why it’s important to discuss contingency plans with your client in the event their home value drops significantly. Other factors, such as the loss of a job or changing family situation could compound the issue.

Once again, discuss a suitable level of emergency funds and consider whether life insurance might be appropriate to help cover expenses in the event a spouse or partner dies.

Impact on retirement savings

Taking on a bigger mortgage translates to taking on more debt, which may make reaching retirement goals or financial independence more difficult. Eager buyers, however, may be compelled to do whatever it takes to get the home of their dreams, even borrow from their IRA or 401(k) to scrape together enough for a down payment. This strategy may be shortsighted and create a retirement shortfall down the road. 

What’s more, any money borrowed from either type of account before age 59½ for reasons other than a qualifying hardship will likely result in a 10% early withdrawal penalty.4 Not only will the client relinquish a portion of their account’s value, they’ll also miss out on compounding interest on that amount over time.

While there are many financial implications of home ownership, it might still be a good decision that turns out to be a great investment. Even so, when it comes to buying a new home, emotions can get the best of the most prudent investor. Understanding what influences emotions and the resulting behaviors can help you address your clients’ needs more fully. 

Use our award-winning Behavioral Finance Advice program to help guide them through major life events and improve decision making with a values-based approach. 

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