It’s a real estate buyer’s market in most areas of the country, but many would-be house purchasers — especially first-timers — remain on the sidelines, waiting for home prices to fall still further.

They may be outsmarting themselves.

With U.S. home prices falling well from their highs, surging inventories of unsold homes and the threat of more foreclosures on the horizon, the housing market has been tilted strongly toward buyers in the past year. In some parts of the country, market-rate housing is falling back into affordable territories and those who were once priced out of the market are now taking a second look.

Some experts say the values still have a long way to fall, leaving potential first-time buyers wondering if they should hold out for lower prices. No doubt that’s a good question, but waiting also carries the risk that interest rates and home prices could start rising. Experts say timing the market correctly is almost impossible and that for a traditional homeowner — who should be taking a long-term outlook approach — timing is irrelevant.

Looking on a local level

According to the National Association of Realtors, or NAR, the median price of a single-family home in the U.S. in the fourth quarter of 2007 was $206,200, down from a peak of $223,500 in the second quarter of 2007. Last year, home values posted the first yearly decline in 16 years and home prices fell almost 9 percent, the largest decline on the Case-Shiller home price index in at least 20 years.

“The risk in waiting is that they (buyers) could end up paying more than they need to, whether that is on the price of the home or the monthly payment because of the interest rates,” says Bonnie Abbott, a professional real estate consultant from Seattle.

Abbot cautions against generalizing the real estate market on a national level and says to look more at local factors. She says Seattle is currently experiencing an influx of job opportunities which may prevent the market from declining any further. She also points to the fact that many homes in all markets are still sold based on “life changes,” such as births, divorces, deaths, downsizing and relocation, which means that people will continue to buy and sell homes on some level no matter what the economy is doing.

Stuart McAfee, a Realtor with Oakhurst Properties in the San Francisco Bay area, believes prices have hit bottom in his area because investors are starting to buy properties. He says the doom and gloom portrayed in the national media has falsely convinced some people that the sky is falling in everyone’s backyard. Some people point to the subprime mortgage crisis and the resulting foreclosures as a basis for further price decreases, but McAfee says the problems have been blown out of proportion.

“The foreclosures are less than 8 percent of all the mortgages out there. That means that 92 percent of the mortgages are strong, good and solid,” says McAfee.

Lawrence Yun, chief economist for the NAR, says there is so much variation between and within local markets that it’s almost pointless to use national numbers as a means for timing. Away from the coasts in middle America, Yun says, home prices are still well-justified by the fundamentals and are unlikely to see much movement. He points to Indianapolis and Dallas as cities where homes are very affordable when compared to median incomes. And prices that are strongly supported by fundamentals aren’t likely to fall as they have been in the “bubble” areas.

Yun says rather than try to time the market and focus on short-term gains, potential homebuyers should look at a 10-year period, the average time people stay in homes. With a long-term outlook, most homeowners will come out ahead even if they buy now and home values continue to fall during the next year or so.

“People shouldn’t be buying with the intention of flipping now. If they are buying to live in it, and within a typical holding period, nearly all will come out ahead in building equity,” says Yun.

Buy when your time is right

Because their livelihoods and commissions depend on it, few real estate agents will openly admit that any time is a bad time to buy a home. Patrick Killelea, a programmer from Menlo Park, Calif., started documenting the housing market crash three years ago on his Web site. He says potential buyers should focus less on price variations and more on the cost of owning versus the cost of renting. Killelea says home prices on the East and West Coasts are still unjustified and disconnected from fundamentals.

Potential homebuyers should weigh the cost of buying a home versus the cost of renting one of a similar size.

“You can do the math in 10 seconds. You don’t need to time the market; you just need to compare the cost of owning with the cost of renting. On the coasts, it’s not even close,” says Killelea.

While the cost of renting and the cost of owning are quite similar in much of middle America, Killela says it is far cheaper to rent in California, for example, where rents can be less than 3 percent of the purchase price of a home.

The buyer of a $400,000 home who put 10 percent down and had a $360,000 mortgage at 6 percent would make monthly payments of principal and interest of $2,158. Add in $600 a month for taxes and insurance and the monthly payment would be $2,758. If an identical home were to rent at 5 percent of its value, the monthly rent would be only $1,666 ($400,000 x 0.05 divided by 12) — a savings of $1,092 per month. A renter who invests that difference can come out ahead of the homeowner and, Killelea says, accumulate far more wealth by renting instead of buying real estate at unjustified price levels.

“The declines (in home prices) aren’t enough to make me want to buy yet. My rent used to be about 2.5 percent of the cost of buying. It has gone up slightly for the first time in seven years but would have to be near the cost of owning (6 percent to 9 percent) for me to buy,” says Killelea.

You can make your own calculations simply by measuring the total cost (including principal, interest, insurance, taxes and maintenance) of buying a home against the cost of renting a similar-sized home. If the two numbers are within 10 percent to 20 percent of each other, it may be worth buying, but in a market where renting is three times cheaper than owning, Killelea says it’s a no-brainer.

Yun says buyers should focus less on timing the housing market and more on determining the right time for them to buy a house. People not ready financially or mentally or who may be moving in the short term shouldn’t buy a home just because market conditions are good, Yun says. He says it is still a good time for homeowners with a long-term view, whether or not there are further price declines.

“For people that have the financial capacity, the conditions are right. There are still historically low mortgage rates and plenty of homes to choose from. I would say buyers should still talk to sellers to negotiate lower prices because now is a great opportunity to do that,” says Yun. In soft markets, buyers are often encouraged to start making offers at least 10 percent less than the asking price.

On a $250,000 home, that’s a $25,000 discount, which could more than make up for any further price declines the market may experience, says McAfee, who recommends that homeowners who are on the fence and think prices may fall further should just make a lower offer.

“If you don’t think that’s the best deal you can get, just make an offer. You’re probably better off making the offer than sitting around waiting for the price to fall,” says McAfee.

Consider the purchase of a $250,000 home with a 20 percent down payment — $50,000 down and a $200,000 mortgage. A 30-year fixed rate mortgage at 6 percent interest would mean monthly payments of $1,199.

If the buyer were to get the home for 5 percent less (a $12,500 discount), or $237,500, and put 20 percent down ($47,500), the monthly payment would be $1,139 — a savings of $60 a month. Over 10 years that would mean a savings of $7,200.

But what if the interest rate went up 1 percent while the buyer was waiting for prices to drop that same 5 percent? The same mortgage at 7 percent interest would mean monthly payments of $1,264 — or $125 a month more than the 6 percent mortgage and even $65 a month more than buying the house at the full price while the interest rate was lower.

Price vs. interest rate
Sale price: $250,000 $237,500 $237,500
Down payment: $50,000 $47,500 $47,500
Amt. financed: $200,000 $190,000 $190,000
Interest rate: 6% 6% 7%
Mo. payment: $1,199 $1,139 $1,264
10-year interest paid: $111,263 $105,700 $124,732
10-year principal paid: $32,269 $30,998 $26,957
10-year total paid: $143,532 $136,698 $151,689

The chart demonstrates that: 1) Over 10 years the buyer saved $6,834 ($143,532 minus $136,698) by negotiating the lower price while interest rates were low; and 2) that a 1 percent higher interest rates cost the buyer $8,157 more — or $815 more a year — despite the sale price.

Put another way, in order to make up for a 7 percent interest rate in the example, a buyer would have to get the sale price down to just over $214,000 and put almost $44,000 down in order to get the same monthly payment of $1,139 — in this case a 14.4 percent price drop.

You can use the Bankrate.com mortgage payment calculator to compute various mortgage/down-payment/monthly payment scenarios. Another tool that can aid in the choice between buying and renting is Bankrate’s rent vs. buy calculator.

Provable income critical

One profound change that has occurred in the housing market is that lending standards have tightened significantly in the past year. First-time homebuyers are generally required to have stronger credit scores and larger down payments than they had over the past few years of easy money.

Melissa Rose, senior mortgage banker with Federal Mortgage Funding in Scottsdale, Ariz., says the biggest changes have been in “stated” income loans. Sometimes called “liar loans,” stated income loans allowed applicants to take out mortgages without verifying their incomes. While these loans may have been abused by some in recent years, they have been very important to self-employed people who can sometimes have difficulty documenting their incomes.

“If they have the income they can prove, it’s much easier to get a loan than having spectacular credit. You really need a down payment. There are no more 100 percent products out there and mortgage insurance has thrown a lot of it out,” says Rose.

Harold “Pete” Bonnikson, senior vice president of mortgage operations for E-LOAN, says that while lending standards have tightened, it is still possible to buy a house with little money down through a Federal Housing Administration, or FHA, loan. Insured by the Federal Housing Administration, FHA loans allow first-time buyers to put down as little as 3 percent. To help cash-strapped owners refinance and to help open more mortgages, limits on FHA loans have also been raised in some higher-priced areas from $417,000 to as high as $729,000.

“It is not as easy for most first-time homebuyers to get a loan as it may have been two years ago. FHA is playing a critical role in the mortgage market now, especially for first-time homebuyers,” says Bonnikson.

Hovering around 6 percent, 30-year fixed mortgage rates are favorable by historical standards where rates have largely stood between 7 percent and 8 percent over the past 20 years. Because long-term rates are determined by the global bond market, not by the Federal Reserve, they tend to rise with inflationary risks. If the economy continues to stumble and the Fed continues to cut short-term rates, long-term mortgage rates may actually move in the opposite direction. Yun recommends that potential homebuyers lock in rates while they’re still favorable.

“Consumers who are relying on what the Federal Reserve is doing will be surprised because mortgage rates at times may be doing exactly the opposite,” says Yun.

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