Stuck in a Starter Home

NEW YORK – If buying a home is an inexorable part of the American dream, so is the next step: eventually selling that home and using the equity to trade up to something bigger.

But over the past two years, this upward mobility has stalled as buyers and sellers have been pummeled by three colliding forces: the highest borrowing rates in nearly two decades, a crippling shortage of inventory, and a surge in home prices to a median of $434,000, the highest on record, according to Redfin.

People who bought their starter home a few years ago are finding themselves frozen in place by what is known as the "rate-lock effect" – they bought when interest rates were historically low, and trading up would mean a doubling or tripling of their monthly interest payments.

They are locked in, and as a result, families hoping to buy their first homes are locked out.

"Home affordability is the worst I've ever seen it," said Daryl Fairweather, Redfin's chief economist.

A year ago, Chris and Alison Wentland were eager to sell their townhouse in the coveted Lincoln Park neighborhood of Chicago, so they hired a real estate agent who sent a photographer to take slick photos of the house, including a 3D video that panned from room to room.

The couple's children – then ages 2 and 6 – shared a room barely big enough to fit a crib and a twin-size bed. A year later, the children share a bunk bed, and the couple haven't even listed the house, much less bought a new one. It's not that they can't find buyers; they just can't afford to sell.

"If I had an open house this weekend, within seven days we'd have an offer, if not multiple offers," said Chris Wentland, 38. "But the flip side to it is: What's going to happen on the other end?"

The other end looks like this: Although they've been lucky enough to accrue equity thanks to rising home prices – the townhouse they bought a few years ago for $538,000 will likely fetch more than $700,000 now – the same wave that lifted their home's value has pushed other homes in their neighborhood out of reach.

It's a financial impasse that is repeating itself across the country. "The take-home message is that people are stuck," said William M. Doerner, a supervisory economist at the Federal Housing Finance Agency.

Locked in

Currently, more than 6 out of every 10 U.S. homeowners have mortgages locked at rates that are extremely low - 4% or less, according to Freddie Mac.

Avoiding the new, higher rates has become a huge deterrent not just to buying but to selling, which in turn has reduced inventory for prospective buyers.

Last year, about 900,000 fewer homes changed hands than in a typical year, according to a research paper by economists at the Federal Housing Finance Agency. The result, according to the authors, "restricts mobility, results in people not living in homes they would prefer, inflates prices, and worsens affordability."

"The starter home for many has become a keeper home, unfortunately," said Susan M. Wachter, a real estate professor at the University of Pennsylvania's Wharton School and a former assistant secretary at the Department of Housing and Urban Development.

Cory Tanzer, the agent representing the Wentlands in Chicago, keeps a Dropbox folder with images of about 50 properties that have been professionally photographed. So far, his clients have been unable to list those properties for fear of not finding a trade-up home they can afford. Tanzer, who leads a team of brokers at the Option Realty Group, has taken to walking the streets of University Village, a neighborhood cater-cornered to the Chicago Loop, knocking on doors to see if anyone wants to sell their home.

To get a laugh, he carries with him an old-fashioned "Wanted" poster showing a mug shot of a townhouse.

Those with less pay more

With buyers and sellers in higher price tiers effectively paralyzed, the weight of the housing market is pressing down hardest on those with the least to spend.

"The trade-up buyer has just disappeared," said Sam Khater, chief economist at Freddie Mac, explaining that homeowners who are unable to upgrade are instead going down in the price continuum. "The lack of supply, it's not just that it's causing prices to go up, but it's causing prices in the bottom half of the price distribution to go up even more."

Prices in the lowest tranche of the housing economy are growing at a faster rate than in any other category. Over the past 20 years, the price for entry-level homes - defined as homes that cost 75% or less than the median in a given market – has nearly tripled, according to CoreLogic, a property information firm.

Every other tier of single-family homes has also increased – just more slowly.

If those conditions weren't tough enough, first-time buyers and people in their first homes are now competing against a wave of investors and all-cash buyers who can forgo the mortgage game - 28% of U.S. homes sold in April were bought entirely in cash, according to the National Association of Realtors®.

The housing crunch

For decades, the U.S. has failed to build enough housing to keep up with demand - a problem that is widespread and affects all types of housing, but is especially pronounced for starter homes, economists say.

During the 1970s, more than 400,000 entry-level homes - defined as those that are no more than 1,400 square feet - were built in the United States each year, according to a report by Freddie Mac. In the 2000s, that number shriveled to about 150,000 a year. By 2020, just 65,000 starter homes were built. Yet 2.38 million people purchased their first homes that year, according to the report.

Among the reasons for the shortage is the price of building materials, which has shot up in the wake of the pandemic. The small margins that builders could expect to make on a smaller home just don't pencil out, said Khater, the Freddie Mac economist.

Many people trying to buy their starter homes are finding only fixer-uppers.

"We can't go buy something that is uninhabitable," said Dania Anderson, 51, who pooled her resources with her sister, Tiffany King, in an effort to buy something in the pricey Bay Area.

They were approved for a combined mortgage of $850,000 before the pandemic and began their house hunt in Oakland, California.

As they waited, the housing market shifted beneath their feet.

Their banker recently told them that they now only qualify for a $750,000 loan – $100,000 had evaporated as rates soared. Now the sisters wonder if they'll be able to enter the housing market at all.

"I saved my money," King said, "but I'm not getting what I want."

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