During the pandemic, it wasn’t unusual for mortgage interest rates to be lower than 5%, which prompted an influx of demand. According to USA Today,¹ the sub-5% rate that 85% of mortgage holders locked in has also encouraged those same homeowners to hold onto their property now that rates are higher than 6%, resulting in low market inventory.

In the past, owning a home exemplified the American dream and was often advised by older generations so that one could establish stability, build equity, and become their own landlord. While these benefits persist, tax-law changes in 2017 that require itemization of deductions for mortgage interest and property tax have reduced some of the advantage. In addition, new limits are now in place on the loan amounts that qualify for deductions of mortgage interest and property tax.

Purchasing is generally recommended over renting if it’s financially feasible and you plan to stay put for at least five years. While growth in home prices varies from market to market, some prime areas are expected to see double-digit increases in the next 12 months. For many people, the decision to postpone homeownership is often driven by a combination of escalating costs, limited inventory, and higher interest rates.

Individuals younger than 35 are more likely to opt for renting,² perhaps because they’re establishing a career, paying down student loans, or spending their paychecks on travel and other experiences. If you’re weighing the pros and cons of homeownership vs. renting, consider the following factors:

Economic conditions

Mortgage interest rates help drive the overall condition of the housing market. In 2021, the average mortgage rate was just below 3%, and in 2022 it rose to just over 5%.³ In 2023, the average rate continued to climb, reaching 7.8% in October, and it has since trended downward to less than 7% in January 2024.

This trend is expected to continue, in tandem with the Federal Reserve rate. All eyes continue to be on the Fed’s next move. The Fed is mandated to achieve maximum employment, keep prices stable, and maintain the effective federal funds rate (EFFR), which is the rate at which commercial banks lend to other banks, ensuring the necessary excess reserves. According to a December 2023 press release, members of the Federal Open Market Committee voted to keep the borrowing rate between 5.25% and 5.5%. Noting that the economy “has slowed” from its strong pace in the third quarter, the committee strongly committed itself to returning inflation to the Fed’s objective of 2% and suggested additional rate cuts will come in 2024.

If the Fed initiates more cuts, analysts expect mortgage rates to follow. In the current environment, many owners who want to sell their home and buy a new one have been waiting for lower mortgage rates. These homeowners will be competing with first-time home buyers for the same houses, resulting in higher prices. In reviewing home prices across the U.S. using the Case–Shiller index, we see that they peaked in June 2022, bottomed out in early 2023, and steadily rose through the year despite high mortgage rates. As stated earlier, this upward trend is expected to continue as mortgage rates decline. Increased competition and a meager supply could mean tough decisions and multiple offers before one is accepted.

How to prepare for homeownership

There’s no crystal ball for determining when the Fed will lower the EFFR. It’s important, however, for potential home buyers to prepare for new and better opportunities. Here are a few tips:

1. Secure a stable cash flow. Good, reliable income is one of the best ways to qualify for a mortgage.
2. Create an emergency fund. Set aside enough money to cover six to 12 months of nondiscretionary expenses, such as rent or mortgage, food, gas, and auto insurance. Save even more if you think an emergency could last longer than a year.
3. Create a maintenance fund. After you establish an emergency fund, save up for unexpected home maintenance costs. Major appliances have lifespans of 10 to 15 years and can cost thousands to replace. Also don’t overlook the cost of furnishing a home.
4. Create an insurance fund. Homeowner’s insurance can cost up to $1,582/year for policy coverage of $350,000.⁴
5. Create a closing costs fund. Closing costs are estimated to be 1% of a home’s sale price. A seller usually covers the majority of closing costs, but some are passed along to the buyer.

Ultimately, it’s always best to plan ahead. Will you need to replace your car in the near term? What other expenses can you anticipate? Are you prepared to change your lifestyle to afford a new home?

Whether you’re planning to rent or purchase, it’s essential to anticipate the future marketplace when determining your next steps. While it’s impossible to predict with certainty the actions of the Fed, the trajectory of mortgage rates, or the ratio of supply and demand in the real estate market, you can take steps now to help prepare for a better financial future. If you’re curious about moving forward, contact your wealth advisor. If you’re not already working with Mercer Advisors, let’s talk.