What a difference a few weeks can make! We started 2020 on a hopeful note, expecting a solid—if moderate—continuation of the longest U.S. expansion on record. The only major obstacles in the housing market, it seemed, would be affordability and availability.
Then came the global expansion of the coronavirus epidemic, and in response, the social and economic landscape has shifted. On March 3, the U.S. Federal Reserve announced a surprise cut of 50 basis points in its short-term interest rate, the largest reduction in borrowing costs since the 2008 Great Recession. But despite this action, a slowdown in economic activity seems inevitable as consumers and companies cut back on travel, conferences, dining, lodging, and other spending, and talk of a recession is increasing.
Traditionally, a recession is marked as a period of two consecutive quarters of decline in the gross domestic product, although other factors also come into consideration. And while historically no two recessions have been alike, they tend to share some key features: rising unemployment, slow or no wage growth, declining prices, and shrinking credit availability.
The last recession, in 2008-09, is considered the second-worst economic contraction in U.S. history, and its effects still linger in our collective memory.
With this in mind, we thought it might be helpful to share our perspective on how a recession may affect the housing market, and how you can prepare for it.
Make your recession plan now
As the popular saying goes, “failure to plan is planning to fail.” But while a plan does not have to be overly complex, it should take into account your circumstances, life stage, goals, and resources.
Start by assessing your financial situation—are you early in your career or nearing retirement? Do you have family and people who depend on you from a financial perspective? Jot down how much you earn and how much money you bring home after taxes. Then compare that figure with how much money you spend on housing, utilities, food, transportation, travel, entertainment, gifts, charitable donations, and other items. Determine which are fixed expenses and where you can make cuts, if necessary. How large is the difference between money coming in and money flowing out?
Loss of a job is a major threat during a downturn, so an essential part of your plan should be saving. Traditionally, financial planners recommended putting aside enough cash to cover three to six months of expenses. However, during the 2008-09 recession many people found themselves unemployed for one year or longer.
Tips for homeowners
Sixty percent of homeowners have mortgage debt, which comes into focus at a time of economic uncertainty. For most Americans, a home is their largest asset and will factor prominently into their financial plan. As a homeowner, you should consider the following:
- Establish an emergency fund: A good rule of thumb is to have at least six months’ worth of living expenses saved in the event you lose your job. If you’re a homeowner, planning to have enough cash to cover your mortgage and unexpected home repairs for six to 12 months is prudent. This may not be feasible, but it is a goal worth aiming for.
- Look for ways to reduce your expenses: Mortgage rates have fallen to historic lows, so there may be an opportunity to lower monthly payments by refinancing, or to make them more predictable by switching from a variable to a fixed-rate mortgage. Often there are fees associated with refinancing, so you will want to compare those with what you’ll be saving over time and how long you think you’ll live in the home. If it costs you $2,000 to save $200 a month, then after you’ve lived in the home for just less than a year, you’ve saved enough to offset the fees, which probably means the refinance makes sense. If you’re not sure that you’ll be in the home long-term or if it will take you a longer time to recoup the fees with your monthly savings, then refinance may not be the best option for you. Also, it’s important to shop around for mortgage loans and make sure you are comparing apples to apples on the interest rate as well as any associated costs. Check rates or use a calculator to see if refinancing makes sense.
- Consider your home an asset: Understand how much equity you have in your home, and research what rates look like for home equity loans. In the event of a job loss, it could make sense to tap into the equity in your home. Check with a financial adviser to see if this might be a good option for you. Tools like MyHome, which gives a view into your property value and equity, can be a good place to start.
- Consider an early payoff: If you’re a longtime homeowner, there may be an opportunity to pay off your mortgage or switch to a shorter-term loan. Those in a 30-year might be able to switch to a 10- or 15-year mortgage at a lower rate. This can help reduce monthly payments or eliminate your mortgage debt, placing your financial situation on a stronger foundation.
Tips for house hunters heading into the spring buying season
Although most people think of recessions with dread, it is worth keeping in mind that they can also be periods of opportunity, especially if you are prepared. As the last recession demonstrated, while asset markets declined, many prepared buyers found treasures, often in low-priced homes. If you’re thinking about buying a home, here are some things to keep in mind:
- Do your financial homework. It’s important to understand your monthly expenses and how much you can comfortably afford. If you’re not feeling confident or comfortable that your income is stable, it might be best to pause your home search.
- Know what you’re looking for. Have a short list of your preferred neighborhoods, home size, features, and commute time to help narrow your search. Understanding the market will help you identify a great buy or hidden gem, as many prepared buyers did during the last downturn.
- Be ready to move quickly. Be prepared with loan pre-approval (which is more solid than pre-qualification) in case your perfect home comes on the market and you need to move quickly to beat out other offers.
- Be patient. Housing inventory has been declining at double-digit rates for the past seven months. This has resulted in a noticeable shortage of homes for sale at all price points, but especially in the affordable range. A quarter of first-time buyers have had to spend over a year on their home search. In these market conditions, it’s important to be prepared, but also patient.
Whether you own a home or are looking to invest for the first time, the important thing to remember is that you can plan for a recession, and it’s never too early to do so.
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