The Property Line: 4 Market Headwinds Facing First-Time Buyers

The COVID-19 pandemic has touched all phases of the homebuying journey. Today’s first-time home buyers find themselves flailing in cross-currents:

• Fearing health risks, homeowners have delayed putting their homes up for sale, limiting supply.

• All-time low mortgage rates have encouraged even more buyers to leap into a fiercely competitive market.

• Meanwhile, tighter mortgage standards make it a bit harder for even well-prepared buyers to get loans.

• Average home prices rise higher, faster — beyond the affordable range for first-timers.

These public health and market forces are amplifying affordability issues for first-time home buyers, threatening to delay their dreams of homeownership. To find success, prospective buyers must be persistent, patient and preapproved.

Sellers slam their doors on buyers

Just as the spring homebuying season was gearing up, word came that the novel coronavirus could spread from person to person. Rather than risk exposure, would-be sellers withheld their homes from the market. "People pulled back because they didn't want people in their homes," says Terri Robinson, a Realtor with RE/MAX Select Properties in Ashburn, Virginia.

As sellers sidelined themselves, the inventory of homes for sale stayed relatively flat instead of zooming upward. In June, 1.54 million existing homes were for sale, a 20% drop from the housing inventory a year before, according to the National Association of Realtors.

A skimpy inventory isn't a problem when demand for homes is low. But even in the pandemic's early days, home buyers outnumbered willing sellers — and the Federal Reserve was about to motivate even more people to go house shopping.

Lower interest rates incite competition

The spread of the coronavirus triggered stay-at-home orders, which spiked unemployment, which begat a recession. Congress and the Federal Reserve firehosed money at the economic downturn to extinguish it. In March, the Fed began buying billions of dollars' worth of mortgage-backed securities to force mortgage rates lower.

The central bank succeeded. The 30-year fixed-rate mortgage averaged 3.86% in January, according to NerdWallet's daily survey. By August it averaged 3.08%, and has remained low since. The dramatic decline gave borrowers more buying power. The prospect of bagging a bargain inspired would-be home buyers to dip their toes into the market.

But these eager buyers discovered that a lot of other people had the same idea. There weren't enough homes for sale to accommodate them. When buyers toured homes and made offers, they discovered they were pitted against one another.

"The competition for those homes becomes much greater," Robinson says. "That's where the struggle is." She recently closed a sale on a condo that attracted 12 offers in four days. It sold for $15,000 more than the asking price. It's the type of home frequently bought by a first-time home buyer — and the competition for those homes is intimidating.

Lenders become choosier

Spooked by coronavirus-related unemployment, mortgage lenders adopted stricter lending standards. Some lenders now require mortgage borrowers to fill out a COVID-19 certification in which they attest that they expect to make the monthly payments.

In another sign of tighter lending requirements, the average credit score on a closed mortgage was 750 in July, compared to 738 in January. That's a sizable jump in just six months.

Lenders have become more conservative with mortgages backed by the Federal Housing Administration as well. Some lenders won't approve FHA loans for borrowers with credit scores below 620, says Jim Sahnger, a mortgage loan officer for C2 Financial Corp. in South Florida. Such a policy disproportionately affects first-time home buyers, who benefit from the FHA’s more relaxed qualification requirements.

Lower rates can't salvage affordability

Combine a small selection of homes, a rate-induced influx of home shoppers and stricter lending requirements. The result? Home prices that rise faster than incomes.

Home affordability for first-time buyers has fallen this year, according to NerdWallet's most recent Metro Affordability Report. A home is generally considered affordable if it costs no more than three times annual income. But most first-timers have to stretch well past that budgetary ideal, according to the report. House prices rose nationally from 4.5 times typical first-time home buyer income in the first quarter to 4.7 times in the second quarter.

First-time buyers tend to make smaller down payments than repeat home buyers, so they often borrow a higher percentage of the home's price. That results in larger monthly mortgage payments, further reducing affordability.

What first-time home buyers can do

First-time home buyers should keep these tips in mind as they navigate the unexpectedly hot housing market:

Be persistent. Robinson stresses to her clients that they might have to make offers on a few homes before they succeed. As clients internalize this message, they're more resilient in the face of disappointment.

Identify the bottom line. Robinson asks buyers she represents, "If you were to lose this house over $500, would you be upset?" If they answer yes, she asks if they want to raise the offer by $500. Then she asks again, until she finds how much the client is willing to pay. That amount might not be the initial offer, but by establishing an upper limit upfront, the client is better prepared to walk away from a bidding war.

Get preapproved to gain a competitive advantage. When home sellers weigh multiple offers, they favor deals that are likely to close. That's why they favor buyers with mortgage preapprovals, Sahnger says.