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The Good, the Bad, the Ugly, and the VERY Ugly of Northern Virginia Real Estate in 2005
By Christy Grimste
This article was written in Spring 2005 by real estate agent and Foreign Service spouse Christy Grimste. For more up-to-date information and alternative opinions on buying, selling, or renting a home in Northern Virginia , AAFSW encourages you to contact a real estate professional or other resources. Send your comments and suggestions to editor@aafsw.org .
Those returning to northern Virginia this summer after several years overseas may be in for a severe case of sticker shock when house-shopping. In Virginia counties immediately surrounding D.C., including Fairfax , Fairfax City , Falls Church, Arlington, and Alexandria, you'll be hard-pressed to find a single family detached home for less than $500,000. The good news is that townhouses are still somewhat reasonably priced and are often the same size as a single family. Our area of Northern Virginia was once a reasonably priced area, what happened, and more important, will it ever be again?
In 2000, thanks to low interest rates that made buying homes more affordable for more people, homeowners in Northern Virginia saw their homes appreciate 5.6%, compared to the 1 to 3% increases during the 1990s. Since then, falling interest rates, rising job growth, and an increasing population have resulted in an increased demand for housing that has set record-breaking home appreciation rates (21% last year). In fact, the rate of home appreciation has outpaced local incomes by as much as two to three times.
Home prices will likely continue to rise even if currently higher interest rates stem the tide slightly. Why? Supply and demand. When demand for a product goes up, so does its price unless supply can increase to equal demand. In Northern Virginia , we simply have more buyers wanting/needing to buy homes than there are homes available. This lack comes from the fact that there is a limited supply of land on which to build. According to a December 2004 report by the Fannie Mae Foundation, the gap between the D.C. metro area's population growth and new housing units has widen every year since 2000. On the demand side of the equation are the area's continued population growth (including more immigrants and late-buying or retiring baby boomers), solid economy (thanks in a large part to increased government contracting), and low unemployment (2% this spring, with new jobs each month). The supply of houses in Northern Virginia is so limited compared to the demand that our market has turned into a kind of housing auction, with multiple buyers bidding on a property far above the asking price.
In such a crazy market, does "affordable" housing even exist? Yes, but generally only if buyers go farther outside the immediate Washington, D.C. metro area and/or settle for a smaller home than they would have liked. The distance one must go to purchase a home without sacrificing size is farther and farther each month. Most high-paying jobs for Northern Virginians are in the District and Arlington and Fairfax counties. Employees want to live close to their place of work and avoid a horrendous commute, so housing prices are high in those counties and their surrounding areas. More affordable homes can be found in Prince William and Loudon counties, even more so in Fauquier and Stafford counties, and farther. Closer in, buyers on a budget can settle for something smaller such as a townhouse or a condo, and maybe trade-up to a single family home later. If you must live closer and don't need the space of a townhouse or single family, condos can be a good option. Just keep in mind that the condo resale market can be tough, as condos are more sensitive to higher interest rates and demographic shifts. Buyers can also get a good deal on a home, sometimes even purchasing at below market value, when they purchase a "fixer upper" home in need of repairs and renovations. These homes are often a great buy if you can find them; unfortunately they can be hard to come by because everyone is looking for them.
Aside from buying something smaller or farther out, house hunters can look to Maryland , where home prices have increased at a lower rate than Northern Virginia , or to the rental market, which is more affordable right now. When deciding what to do, consider the financial pros and cons of buying vs. renting, as well as how much house you can afford. For this, www.eloan.com has some excellent financial calculators.
So, you want to buy a home?
In most cases, owning your own home is preferable to renting, especially considering the high appreciation rate of homes now, which often makes a home as much an investment as a place to live. But, can a family on a modest income afford to buy a house? In a word, yes. Even in this market, homeownership isn't out of the question. Before looking for homes to buy, you'll need to determine how much of a monthly payment you'll qualify for and think about how you'll pay for it.
In theory, you can afford a house that costs as much as the largest monthly mortgage payment for which you qualify. In reality, what you can afford and what you qualify for may be two different things. Only you know what you can reasonably afford in terms of possible future income and expenses so we'll just deal with what you'll qualify for here. To determine how much house you'll qualify for, lenders primarily use two financial ratios: the front-end ratio, which tells them how much of a mortgage payment you can afford in relation to your income, and the back-end ratio, which tells them how much payment you can afford in relation to your debt.
Let's say a GS-13 or FS-02 grosses approximately $6,000 a month and owes payments of $600 each month toward debt. Generally lenders will allow you to pay 29% of your gross income toward your mortgage payment every month (the front-end ratio). In this example, 29% of $6,000 is just under $1,800 a month-so, they'll reason, you can put $1,800 toward your mortgage payment. The back-end ratio, or "debt ratio", is the amount you pay in monthly debt (car payments, credit cards, student loans, etc.) divided by your gross monthly income. Lenders don't want more than 41% of your gross income going to total debt, including your mortgage, credit cards, and other payments. In our example the back-end ratio is 40% ($600 monthly debt payments, and a $1,800 mortgage payment divided by $6,000), which is OK by industry standards. Obviously the less debt you have the more for which you would qualify. These ratios can vary somewhat; the ones used here are just examples.
Exactly how much house you'll be able to buy for an $1800 mortgage payment will depend on current interest rates and how much (if any) you can put toward a down payment. Although interest rates have risen slightly in recent months, 30-year mortgage rates are still relatively low compared with even 3 years ago. As for a down payment, obviously the more money you can put down-from savings, money borrowed from relatives, or equity in a house you've sold-the better. Keep in mind, if you do receive money from relatives, whether a gift or a loan, the money and your intent to repay must be disclosed to your mortgage company. Even if you don't have access to money from relatives or equity in another house, there are still several ways to help pay for a home:
Consider an "interest-only" loan
Every loan is composed of two parts: the interest (the agreed upon percentage you pay for the privilege of borrowing a sum of money) and the principal (the sum of money you are borrowing). With an interest-only mortgage, you pay only the interest on the mortgage in monthly payments for a fixed term (up to 5 years). Payments during this fixed term are 15 to 30% lower than they would be on a conventional mortgage. The down side to the lower payments is that after the end of the term the loan's payments nearly double as you start paying of the principal in addition to the interest. Because of this, most borrowers who go with interest-only loans expect to either sell or refinance their homes before the interest-only period ends. While interest-only loans are usually not a good idea for the long term, if you're only planning on staying in the house for one tour, they can be a life-saver.
Never pay PMI
All lenders require Private Mortgage Insurance (PMI) when the first mortgage on a property is more than 80% of the value (the purchase price) of the property. What that means is that unless you make a down payment of 20% on a home, most lenders will automatically charge PMI, which costs you an additional $200-300 a month and is built into your mortgage payment. Unlike your interest payments, PMI payments are not tax deductible. What many lenders won't tell you is that there is a simple way around paying PMI. Tell them you want an "80-15-5" loan, which means you'll have a first mortgage for 80% of the value of the house, a second mortgage for 15% of the value, and you'll pay 5% down. Depending on the lender's loan options you may be able to put less than 5% down. Structuring the loan in this way makes the first mortgage equal to 80% and exempt from PMI.
Make your TSP work for you
As government employees, we have a financial "ace in the hole" when it comes to purchasing a house. If you have even a small balance in your Thrift Savings Plan, borrowing against it for the purchase of a home can save you money and allow you to afford more house. You can generally borrow half of the balance in your TSP, up to maximum amount of $50,000, as set by the IRS. Not only will you save money by borrowing at an extremely low interest rate (as of May 24, 2005 the interest rate on a TSP loan was 4.25%, compared with 5.875% on a fixed rate conventional mortgage), but the interest you pay on the loan is yours to keep.
Before you balk at the idea of tapping your retirement funds, consider the financial benefits of putting some of your TSP toward a home purchase. Say you were to take out a $50,000 loan from your TSP to be paid off over 15 years (the maximum time limit). At the current TSP interest rate, you would pay approximately $350 a month). If you used $45,000 of the loan as the down payment on a $350,000 house and put the remaining $5,000 toward closing costs, your total house payments would be approximately $2,150 ($1,800 on the $300,000 loan, a 30 year fixed at 5.875%, plus the TSP payment of $350). Compare that to a payment of approximately $2,300 if you financed the entire $350,000 (interest rates are generally higher on a no-money-down loan) with a conventional loan. With your TSP, you'd pay $2,000 less each year and you would be paying off the house sooner (since the TSP is a 15 year loan). Keep in mind, your TSP payments will be included in your back-end ratio (gross monthly income divided by your total debts) for financing purposes. Check out the calculators at www.tsp.gov for different loan scenarios.
Take an extra, temporary job
If you or your spouse worked for a short period of time, you would be able to put aside additional cash for a down payment and/or for future house payments. Live on what you made before (or less) and put the additional income into an interest-bearing account. Depending on the job and the duration of employment, you could sock away enough to make or break your buying power. Every little bit helps!
Whichever options you choose, don't forget to consider the tax benefits of deducting the interest on your mortgage, which translates into money in your pocket. For example, on a $350,000 mortgage you'll be able to deduct approximately $20,000 in interest each year; at a 25% tax rate, you'll shave $5,000 off your total tax bill or $375 a month. Be sure to adjust your tax withholding so that you can take that additional cash home in your pay check instead of at tax time.
Christy Grimste is a Foreign Service spouse and a real estate agent with Jobin Realty. Feel free to email her at christygrimste@gmail.com with any questions about real estate.