Condos were picked as an affordability favorite early on in the pandemic, with more availability at competitively lower prices (versus urban single family homes), and competition might be higher still for condos with affordability pressures mounting.
Manufactured homes, with far lower prices and more available inventory, offer an opportunity for affordability, until financing gets involved.
Vacant lots might give buyers more time to make a decision, and the opportunity now with falling lumber prices to build exactly what buyers are looking for.
It comes as no surprise to many that the housing market has been largely driven by affordability constraints in recent months, as volatile mortgage rates clash with high home values, and household incomes lag far behind prices. While single family homes dominate much of the available inventory on the market and are how most people imagine the typical ‘home’, there are many other alternative property types. Most offer some reprieve when it comes to affordability.
High density urban living has its (affordability) perks
In the early days of the pandemic, when job centers and urban cores hit the pause button, condos became a widely available and affordable alternative. But with more and more COVID-19 restrictions behind us, accommodation and food service employment on the rise, and homeowners and renters alike drawing back to the urban core, condo inventory dropped off a cliff similar to all other property types during the low mortgage rates of the pandemic, just roughly a year delayed.
As mortgage rates started their climb, condos saw a steep rise in the share of listings with a price cut. But compared to pre-pandemic norms, price cuts on condos haven’t jumped quite as much as for single family homes. Competition for condos, while certainly slowing, is not receding at quite the same cadence as for single family homes. Despite the typical value of a condo matching that of the typical single family home and the pricey addition of a monthly HOA payment, condos may still be an attractive affordable alternative to single family homes for urban dwellers. Condos are concentrated in urban areas where price per square foot is much higher, so the affordability comparison to urban single family homes still puts condos on top (the typical value of urban condos in March was $405,857 compared to $610,583 for urban single family homes).
Manufactured homes might be the answer we have all been looking for
A corner of the market even more known for affordability is manufactured homes. Using the efficiencies of a factory production line, manufactured homes come with a much smaller price tag than site-built (condos and single family) units, giving more opportunities for ownership for lower and middle income households. But the ability to make a structure or structure components affordable at scale is only part of the story.
Still impacted by the price of land and the imbalance of housing supply and demand, the price of manufactured housing has risen significantly over the past three years. Median list prices for manufactured homes reached almost 30% annual growth right before the rate hikes entered the market in early 2022. Despite this the median list price for manufactured homes is still far below that of site-built homes. The tricky side of affordability for manufactured homes comes with financing the purchase.
Many lenders don’t necessarily classify manufactured homes as “real property” in the same way they classify a site-built home. This can lead to higher rates and more challenges with being approved for a mortgage. According to preliminary data from the 2022 Home Mortgage Disclosure Act, [1] the median interest rate on an approved mortgage for a manufactured home purchase was 6.25% – over one full point above the 2022 median rate of 5% for site-built home mortgages. And not all manufactured home mortgages are made equal. From the preliminary 2022 HMDA data, the difference between rates on approved mortgages for manufactured homes where the borrower directly owned the land the home was on and approved mortgages where the borrower was in a paid lease for the land was 5.75% to 8%. With more potential buyers on the edge of qualifying, manufactured home mortgage denial rates topped 41.7% (that is, over 4 out of 10 applicants for manufactured homes are denied) compared to just 7.8% (or about 1 in 14) for site-built mortgage applicants. And for those who are approved for a mortgage on these prefabricated homes – loan limits and loan terms can be another hurdle. The HUD guidelines for manufactured home loans sets a limit of just under $70,000 for the max value for a loan, and the term limit is 20 years, compared to the typical 30 year loan for a site-built home. So while prices of manufactured homes went up so far in the last few years, that $70,000 loan limit doesn’t cover quite as much, requiring higher down payments to keep the loan limit in check.
With these pre-existing premiums on mortgage rates (and stricter mortgages overall) for manufactured homes and lower median incomes among buyers ($64,000 vs $105,000 for site built buyers), the manufactured homes market responded similarly to the single-family market, despite its more affordable price point, as mortgage rates started to rise in early 2022. As the market shifted, sellers for manufactured homes had to adjust their expectations from the rapid acceleration in prices that proceeded early 2022, with manufactured home prices now decelerating fast. As such, the share of listings with a price cut climbed way up from pre-pandemic norms as demand was shut out.
With many prospective buyers likely blocked from the market due to incredibly high rates, manufactured home inventory rose sharply and manufactured homes sat on the market for longer waiting for buyers to be able to break through the affordability barrier.
Vacant lots can provide a world of possibility
Finally, vacant lots are a possible alternative to buying an already built home. These offer the option to build something custom that’s exactly to your liking, which may entice more buyers in today’s market given the low flow of new inventory leaving few existing options to pick over. One benefit in shopping for vacant lots is the slower pace at which these listings move. The typical lot listing went pending after more than two months on the market, giving buyers who are pursuing a build-it-from-the-ground-up plenty of time to critically evaluate all of their options. But much like manufactured homes, lots come with tricky financing. Often requiring a hard money loan which carries a really hefty price tag in a normal market, and even more so now with rates hovering around 6.5%. While the vacant lot market is also slowing down dramatically now that rates have departed their pandemic lows, lumber prices have thankfully come down from an acute pandemic-era price surge, easing the price burden for breaking ground on a new home on these lots.
Even once mortgage rates ease and housing has returned to a more stable market, affordability will remain a challenge. Traditionally constructed units too often do not pencil for builders without luxury features and large sticker prices. Reaching inventory levels able to sustain the current and future flow of demand from strong demographic dynamics (think: a lot of millennials buying their first home at the same time as baby boomers are looking to retire and downsize) will require more creative means of construction and a mortgage market friendlier to manufactured, or other exciting new alternatives like 3D printing and modular construction. With a historically high number of manufactured homes shipping out across the country, perhaps momentum behind affordable inventory is on its way.
[1] From data pulled April 3rd, 2023. The 2022 HMDA data is not officially finalized and is still accepting revisions from lenders.
Have you ever thought about doing a cash-out refinance on your home for investment?
A lot of people have.
I received exactly this question from a reader.
Reader Question
Hi Jeff,
Thanks for your videos and educational websites!
I know you are very busy and this may a simple answer so thank you if can take the time to answer!
Would you ever consider approving someone to taking a cash-out refi on the equity in their house to invest?
I have been approved for a VA 100% LTV cash-out refi at 4% and would give me 100k to play with.
With average ROI on peer to peer, Betterment, Fundrise, and S&P 500 index funds being 6-8%, it seems like this type of leveraging would work. However, this is my primary residence and there is an obvious risk. I could also use the 100k to help buy another property here in Las Vegas, using some of the 100k for a down and rent out the property.
BTW, I would be debt free other than the mortgage, have 50k available from a 401k loan if needed for an emergency, but with no savings. I have been told this is crazy, but some articles on leveraging seem otherwise as mortgages at low rates are good at fighting inflation, so I guess I am not sure how crazy this really is.
I would greatly appreciate a response and maybe an article or video covering this topic as I am sure there are others out there who may have the same questions.
My Thoughts
But rather than answering the question directly, I’m going to present the pros and cons of the strategy.
At the end, I’ll give my opinion.
The Pros of a Cash-Out Refinance on Your Home For Investment Purposes
The reader reports he’s been told the idea is crazy.
But it’s not without a few definite advantages.
Locking in a Very Low-Interest Rate
The 4% interest rate is certainly attractive.
It will be very difficult for the reader to borrow money at such a low rate from virtually any other source. And with rate inching up, he may be locking into the best rates for a very long time.
Even better, a home mortgage is very stable debt. He can lock in both the rate and the monthly payment for the length of the loan – presumably 30 years. A $100,000 loan at 4% would produce a payment of just $477 per month. That’s little more than a car payment. And it would give him access to $100,000 investment capital.
As long as he has both the income and job stability needed to carry the payment, the loan itself will be fairly low risk.
So far, so good!
The Leverage Factor
Let’s use an S&P 500 index fund as an example here.
The average annual rate of return on the index has been right around 10%.
Now that’s not the return year in, year out. But it is the average based on nearly 100 years.
If the reader can borrow $100,000 at 4%, and invest it and an average rate of return of 10%, he’ll have a net annual return of 6%.
(Actually, the spread is better than that, because as the loan amortizes, the interest being paid on it disappears.)
If the reader invests $100,000 in an S&P 500 index fund averaging 10% per year for the next 30 years, he’ll have $1,744,937.That gives the reader a better than 17 to 1 return on his borrowed investment.
If everything goes as planned, he’ll be a millionaire using the cash-out equity strategy.
That’s hard to argue against.
Rising Investment, Declining Debt
This adds an entire dimension to the strategy. Not only can the reader invest his way into millionaire status by doing a cash-out refinance for investment purposes, but at the end of 30 years, his mortgage is paid in full, and he’s once again in a debt-free home.
Not only does his investment grow to over $1 million, but over the 30 year term of the mortgage, the loan self-amortizes down to zero.
What could possibly go wrong?
That’s what we’re going to talk about next.
The Cons of a Cash-out Refinance on Your Home
This is where the prospect of doing a cash-out refinance on your home for investment purposes gets interesting.
Or more to the point, where it gets downright risky.
There are several risk factors the strategy creates.
Closing Costs and the VA Funding Fee
One of the major disadvantages with taking a new first mortgage are the closing costs involved.
Whenever you do a refinance, you’ll typically pay anywhere from 2% to 4% of the loan amount in closing costs.
This will include:
origination fees
application fee
attorney fee
appraisal
title search
title insurance
mortgage taxes
and about a dozen other expenses.
If the reader were to do a refinance for $100,000, he would only receive between $96,000 and $98,000 in cash.
Then there’s the VA Funding Fee.
This is a mortgage insurance premium charged on most VA loans at the time of closing. It’s usually added on top of the new loan amount.
The VA funding fee is between 2.15% to 3.30% of the new mortgage amount.
Were the reader to take a $100,000 mortgage, and the VA funding fee set at 2.5%, he’d owe $102,500.
Now… let’s combine the effects of both the closing costs in the VA funding fee. Let’s assume the closing costs are 3%.
The borrower will receive a net of $97,000 in cash. But he will owe $102,500. That is, he will pay $102,500 for the privilege of borrowing $97,000. That’s $5,500, which is nearly 5.7% of the cash proceeds!
Even if the reader gets a very low-interest rate on the new mortgage, he’s still paid a steep price for the loan.
From an investment standpoint, he’s starting out with a nearly 6% loss on his money!
I can’t recommend taking a guaranteed loss – upfront – for the purpose of pursuing uncertain returns.
It means you’re in a losing position from the very beginning.
The Interest on the Mortgage May No Longer be Tax Deductible
The Tax Cuts and Jobs Act was passed in December 2017, and applies to all activity from January 1, 2018, forward.
There are some changes in the tax law which were not favorable to real estate lending.
Under the previous tax law, a homeowner could deduct the interest paid on a mortgage of up to $1 million, if that money was used to build, acquire or renovate the home. They can also deduct interest on up to $100,000 of cash-out proceeds used for purposes unrelated to the home.
That could include paying off high interest credit card debts, paying for a child’s college education, investing, or even buying a new car.
But it looks like that’s changed under the new tax law.
Borrowing up $100,000 for purposes unrelated to your home, and deducting the interest looks to have been specifically eliminated by the new law.
It’s now widely assumed that cash-out equity on a new first mortgage is also no longer deductible.
Now the law is still brand-new and subject to both interpretation and even revision. But that’s where it stands right now.
There may be an even bigger obstacle that makes the cash-out interest deduction meaningless, anyway.
Under the new tax law, the standard deduction increases to $12,000 (from $6,350 under the previous law) for single taxpayers, and to $24,000 (up from $12,700 under the previous law) for married couples filing jointly. (Don’t get too excited – personal exemptions are eliminated, and combined with the standard deduction to create a higher limit.)
The long and short of it is with the higher standard deduction levels, it’s much less likely mortgage interest will be deductible anyway. Especially on the loan amount as low as $100,000, and no more than $4,000 in interest paid.
Using the Funds to Invest in Robo-advisors, the S&P 500 or Peer-to-Peer Investments (P2P)
The reader is correct that these investments have been providing steady returns, well in excess of the 4% he’ll be paying on a cash-out refinance.
In theory at least, if he can borrow at 4%, and invest at say, 10%, it’s a no-brainer. He’ll be getting a 6% annual return for doing virtually nothing. It sounds absolutely perfect.
But as the saying goes, if it looks too good to be true, it probably is.
I often recommend all of these investments, but not when debt is used to acquire them.
That changes the whole game.
Whenever you’re thinking about investing, you always must consider the risks involved.
The last nine years have somewhat distorted the traditional view of risk.
For example, the stock market has been up nine years in a row, without so much as a correction of greater than 10%. It’s easy to see why people might think the returns are automatic.
But they’re not.
Yes, it may have been, for the past nine years. But if you look back further, that certainly hasn’t been the case.
The market has gone up and down, and while it’s true that you come out ahead as long as you hold out for the long term, the debt situation changes the picture.
Matching a Certain Liability with Uncertain Investment Returns
Since he’ll be investing in the market with 100% borrowed funds, any losses will be magnified.
Something on the order of a 50% crash in stock prices, like what happened during the Dot.com Bust and the Financial Meltdown, could see the reader lose $50,000 in a similar crash.
But he’ll still owe $100,000 on his home.
This is where human emotion comes into the picture. Since he’s playing with borrowed money, there’s a good chance he’ll panic-sell his investments after taking that kind of loss.
If he does, his loss becomes permanent – and so does his debt.
The same will be true if he invests with a robo-advisor, or in P2P loans.
Robo-advisor returns are every bit as tied to the stock market as an S&P 500 index fund is. And P2P loan investments are not risk-free.
In fact, since most P2P investing and lending has taken place only since the Financial Meltdown, it’s not certain how they’ll perform should a similar crisis take place.
None of this is nearly as much a problem with straight-up investing based on saved capital.
But if your investment capital is coming from debt – especially 100% – it can’t be ignored.
It doesn’t make sense to match a certain liability with uncertain investment gains.
Using the Funds to Buy Investment Property in Las Vegas
In a lot of ways, this looks like the most risky investment play offered by the reader.
On the surface, it sounds almost logical – the reader will be borrowing against real estate, to buy more real estate. That seems to make a lot of sense.
But if we dig a little deeper, the Las Vegas market in particular was one of the worst hit in the last recession.
Peak-to-trough, property values fell on the order of 50%, between 2008 in 2012. Las Vegas was often referred to as the “foreclosure capital of America”.
I’m not implying the Las Vegas market is doomed to see this outcome again.
But the chart below from Zillow.com shows a potentially scary development:
The upside down U formation of the chart shows that current property values have once again reached peak levels.
That brings the question – which we cannot answer – what’s different this time? If prices collapsed after the last peak, there’s no guarantee it can’t happen again.
Once again, I’m not predicting that outcome.
But if you’re planning to invest in the Las Vegas market with 100% debt, it can’t be ignored either. In the last market crash, property values didn’t just decline – a lot of properties became downright unsalable at any price.
The nightmare scenario here would be a repeat of the 2009-2012 downturn, with the reader losing 100% of his investment. At the same time, he’ll still have the 100% loan on his home. Which at that point, might be more than the house is worth, creating a double jeopardy trap.
Once again, the idea sounds good in theory, and certainly makes sense against the recent run-up in prices.
But the “doomsday scenario” has to be considered, especially when you’re investing with that much leverage.
Putting Your Home at Risk
While I generally recommend against using debt for investment purposes, I have an even bigger problem when the source of the debt is the family homestead.
Borrowing money for investment purposes is always risky.
But when your home is the collateral for the loan, the risk is double. You not only have the risk that the investments you’re making may go sour, but also that you’ll put your home at risk in a losing venture.
Let’s say he invests the full $100,000. But due to leverage, the net value of that investment has declined to $25,000 in five years. That’s bad enough. But he’ll still owe $100,000 on his home.
And since it’s a 100% loan, his home is 100% at risk. The investment strategy didn’t pan out, but he’s still stuck with the liability.
It’ll be a double whammy if the money is used for the purchase of an investment property in your home market.
For example, should the Las Vegas market take a hit similar to what it did during the Financial Meltdown, he’ll not only lose equity in the investment property, but also in his home.
He could end up in a situation where he has negative equity in both the investment property and his home. That’s not just a bad investment – that’s a certified nightmare!
It could even lead him into bankruptcy court, or foreclosures on two properties – the primary residence and the investment property. The reader’s credit would pretty much be toast for the next 10 years.
Right now, he has zero risk on his home.
But if he does the 100% cash out, he’ll convert that zero risk to 100% risk. Given that the house is needed as a place to live, this is not a risk worth taking.
Final Thoughs
Can you tell that I don’t have a warm, fuzzy feeling about the strategy? I think you figure it out by the greater emphasis on Cons than on Pros where I come down on this question.
I think it’s an excellent idea in theory, but there’s just too much that can go wrong with it.
There are three other factors that lead me to believe this is probably not a good idea:
1. The Lack of Other Savings
The reader reports that he has “…50k available from a 401k loan if needed for emergency, but with no savings.”For me, that’s an instant red flag. Kudos to him for having no other debt, but the absence of savings – other than what he can borrow against his 401(k) plan – is setting off alarm bells.
To take on this kind of high risk investment scheme without a source of ready cash, exaggerates all of the risks.
Sure, he may be able to take a loan against his 401(k), but that creates yet another liability.
That that will need to be repaid, and it will become a lien against his only remaining unencumbered asset (the 401k).
If he has to borrow money to stay liquid during a crisis, it’s just a question of time before the strategy collapses.
2. The Reader’s Risk Tolerance
We have no idea what the reader’s risk tolerance is.
That’s important, especially when you’re constructing a complex investment strategy.
While it might seem the very fact he’s contemplating this is an indication he has a high risk tolerance, we can’t be certain. He’s basing his projections on optimistic outcomes – that the investments he makes with the borrowed money will produce positive returns.
What we don’t know, and what I ask the reader to consider, is how he would handle a big reversal.
For example, if he goes ahead with the loan, invests the money, and finds himself down 20% or 30% within the first couple of years, will he be able to sleep at night? Or will he instead contemplate an early exit strategy, that will leave him in a permanent weakened financial state?
These are real risks that investors face in the real world. At times, you will lose money. And how you react to that outcome can determine the success or failure of the strategy.
This is definitely a high risk/high reward plan. Unless he has the risk tolerance to handle it, it’s best not to even start.
On the flip side, just because you have the risk tolerance, doesn’t guarantee success.
3. Buying at a Market Peak
I don’t know who said it, but when asked where the market would go, his response was “The market will go up. And the market will go down”.
That’s a fact, and one that every investor has to accept.
This isn’t about market timing strategies, but about recognizing reality.
Here’s the problem: both the financial markets and real estate have been moving up steadily for the past nine years (but maybe a little bit less for real estate).
Sooner or later, all markets reverse. These markets will too.
I’m worried that the reader might be borrowing money to leverage investing at what could turn out to be the absolute worst time.
Ironically, a borrow-to-invest strategy is a lot less risky after market crashes.
But at that point, everyone’s too scared, and no one wants to do it. It’s only at market peaks, when people believe there’s no risk in the investment markets, that they think seriously about things like 100% home loans for investments.
In the end, the reader’s strategy could be a very good idea, but with very bad timing.
Worst Case Scenario: The Reader Loses His Home in Foreclosure
This is the one that seals the deal against for me. Doing a cash out refinance on your home for investment is definitely a high-risk strategy.
Heads you’re a millionaire, tails you’re homeless.
That’s not just risk, it’s serious risk. We don’t know if the reader also has a family.
I couldn’t recommend anyone with a family putting themselves in that position, even if the payoff were that high.
Based on the facts supplied by the reader, we’re looking at 100+% leverage – the 100% loan on his house, then additional (401k) debt if he runs into cash flow problems. That’s the kind of debt that will either make you rich, or lead you to the poor house.
Given that the reader has a debt-free home, no non-housing debt, and we can guess at least $100,000 in his 401(k), he’s in a pretty solid situation right now. Taking a 100% loan against his house, and relying on a 401(k) loan for emergencies, could change that situation in no more than a year or two.
Save more, spend smarter, and make your money go further
You’re finally ready to get out of the rental market and buy a home of your own. But how do you know how much house you can afford?
Before you head out on your house-hunting adventure, you can easily do those affordability calculations yourself before you officially begin shopping for a mortgage.
Here are the top factors lenders typically consider when determining how much house you can afford.
Debt-to-income ratio
One of the first factors a lender will analyze is your debt-to-income ratio, or DTI.
Lenders use this measurement to ensure that you’ll have enough income to cover both your new mortgage payment and any existing monthly debts such as credit card, auto loan and student loan payments.
What is a good debt-to-income ratio? Generally most lenders want your debt-to-income ratio, including your anticipated new monthly mortgage payment, not to exceed 36 percent.
The ratio is calculated by taking your total monthly debt load and dividing it by your monthly gross income.
What does that mean in dollars and cents? Someone who earns $5,000 per month and carries $500 in monthly debt would have a DTI of 10 percent.
This borrower generally could be approved for a maximum monthly mortgage payment of $1,300, including property taxes, homeowners insurance and private mortgage insurance.
Someone making the same salary but carrying zero debt generally could be approved for a maximum monthly mortgage payment of $1,800.
Credit considerations
There are several key factors in securing a mortgage loan, and your credit is one of the most important elements.
Your credit scores is based on your payment history, overall level of debt, length of credit history, types of credit and applications for new credit.
If a traditional lender finds that your credit score falls within an undesirable range or includes unfavorable marks when they check your credit report, they might be leery of approving you for a loan.
You may be able to obtain a loan, but you’ll likely pay a higher mortgage rate, which will ultimately result in a higher mortgage payment.
Well before you apply for a home mortgage loan, pull your credit report to review where you stand, and research the requirements you need to meet with your desired lender.
Understanding your personal credit profile and the lender’s expectations will help you understand the interest rates you likely qualify for and the terms your loan will likely be.
Down payment requirements
With the exception of Veterans Affairs (VA) loans and some special programs for first-time buyers, a home purchase requires that you have some cash on hand.
How much? Anywhere from 3.5 percent of the sales price for a Federal Housing Administration (FHA) loan to as much as 20 percent for a conventional loan.
Expect to get a better interest rate if you’re able to make a down payment of at least 20 percent.
Keep in mind that the down payment amount doesn’t include closing costs, which are fees related to the purchase of the home.
Typically, buyers pay between 2 percent and 5 percent of the purchase price of the home in closing costs.
The big picture
If you have less-than-amazing credit, then you may want to consider waiting to purchase a home and making changes in your spending habits to improve your credit score.
Many experts suggest before you even consider buying a home, you should be debt-free and have three to six months of expenses saved — in addition to your down payment and closing costs.
“Being debt-free or close to it with some money in the bank is optimal,” said Tiffany Kjellander, owner and operations manager of Augusta, NJ-based EXIT Towne & Country Realty.
She adds, “It can be tough to hear that it’s not the right time for you to look for a house, but the truth is that getting your financials in order and putting some money in the bank could keep you from losing your home if you get sick or lose your job down the road.”
Further, Kjellander advises that potential homeowners think long term.
The cost of homeownership extends beyond the monthly payment and includes routine maintenance and repairs, homeowners association dues and additional utilities that you might not have paid while renting.
“Just because you’re approved to spend $3,000 per month on a house doesn’t mean you have to go that high,” she said. “Buying a home is a huge financial decision. No one should enter into it blindly.”
“How Lenders Determine How Much House You Can Afford” was provided by Zillow.
Save more, spend smarter, and make your money go further
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