How homebuyers are climbing the sacrifice ladder

Transcript:

Allie Barefoot: Welcome back to Data in Context. I'm Allie Barefoot with Cotality. In today's housing market, high mortgage rates and ongoing affordability pressures are forcing buyers to make some tough decisions. But instead of walking away from the market entirely, prospective homebuyers are choosing to adapt, renegotiating their priorities in a very specific and structured order. Cotality analysts call this 'the sacrifice ladder.' It's the step-by-step tradeoffs buyers are willing to make just to get approved and into their home. So today, we're unpacking what buyers are willing to cut first, how they're restructuring their loans, and what they're fighting to protect until the absolute last resort. To do so, we're going to be talking with Cotality's Chief Economist, Dr. Selma Hepp. Let's put the data into context. Welcome back to Data in Context, Selma. It's always great to have you on for our monthly Home Price Index reports, but now we're talking about something a little different, so thank you for being our guest today.

Dr. Selma Hepp: Thanks for having me, Allie. It's always a pleasure to talk to you.

Allie Barefoot: Well, great! So we're actually talking about the Sacrifice Ladder. And when we talk about the housing market and high interest rates and affordability, the headlines really make it seem like the buyers are just kind of throwing in the towel and not trying to get into the housing market. But Cotality research shows that buyers aren't breaking, they're bending. And that's where that Sacrifice Ladder really comes in. So I wanted to ask you, kind of walk us through the order of this ladder, and what does it tell us about the larger market?

Dr. Selma Hepp: Yeah, to me, the ladder is telling us that demand has not disappeared; it's just being rationed through tradeoffs. You know, buyers tend to protect their homebuying—the idea of homebuying itself—and then absorb the shock elsewhere. What I mean by that: they cut discretionary spending, they pause maybe the search for later down the road, or they change the financing before accepting a smaller or less desirable property. That really helps explain why affordability pressures continue to coexist with these high and resilient prices. Households may transact less, wait longer, or stretch differently, but they still want to own a home. And really, the larger market story is that one of delayed and reshaped demand. It's not simply a story of destroyed demand. The question for some is, you know, delayed for how long? When we look at the turnover data and even demographic data, you know, we know that there's a significant pent-up demand that exists, and it has built up particularly over the last few years as affordability became such a challenge.

Allie Barefoot: And I want to metaphorically walk up this ladder here with you. And you said cutting discretionary spending. That's actually that bottom first step as we move up the ladder. And Cotality analysis shows us that 69% of buyers, they do start by cutting their lifestyle spending. But with inflation driving up everyday life costs, discretionary cash can disappear fast, and there's not so much left afterwards to put towards a house and to savings. So in practice, what does cutting lifestyle spending really look like when inflation is kind of squeezing every dollar?

Dr. Selma Hepp: Yeah, that's a great question. Really, in practice, what it means: it means fewer restaurant trips, fewer DoorDashes, for example, fewer international trips or just, you know, girls' trips. Maybe it's postponing a car purchase, it's cutting subscriptions, delaying maybe some major household purchases, and generally redirecting savings towards a down payment or that monthly payment. Some buyers may also move in with their family members and even stay longer than they initially anticipated, or take on additional work. But the key point is that these are not infinitely renewable savings, right? Inflation has already raised the cost of necessities for so many of us and on so many goods, so the discretionary bucket is smaller, and the tradeoffs do become more painful. That creates a spillover beyond housing. For example, a buyer who preserves the home purchase may reduce spending across the rest of the local economy, which may slow that economy itself, too. So it's a self-perpetuating cycle.

Allie Barefoot: Yeah, if I had to cut DoorDash out of my lifestyle, that would be a very painful cost-cutting sacrifice! But I completely see what you're talking about, and I feel like once that personal squeeze is pushed as far as you can go and you've cut out everything that you can possibly cut out, that's where we hit that next step in the ladder. As 65% of buyers Cotality found, they take that next step, which is adjusting the financing. How are buyers and lenders getting creative with loan structures today?

Dr. Selma Hepp: Yeah, this is really something that's become really obvious today, where buyers are combining several levers. They may be purchasing with mortgage rate buydowns, they are increasingly using adjustable-rate mortgages where appropriate, increasing maybe down payments, accepting smaller loan balances, and also turning to family assistance and co-borrowers. Builders have been especially effective in this at using incentives and permanent or temporary buydowns to lower that monthly payment. Lenders are now increasingly competing in that way, too. But another way in which lenders are competing is certainty, meaning clear underwriting, predictable closing, products that are tailored to buyer's cash flow are really important to potential buyers. And actually, in the global survey, we see that 71% of buyers value certainty over speed, so it's not just about speed. But the caution here is that creativity should improve affordability, not disguise it. The loan still has to work even after that introductory rate or when the incentive expires. And that's something that we've been seeing or having a radar on lately, is looking at what's happening with adjustable-rate mortgages that were originated over the last few years. Some of those buyers may have been hoping for lower rates when their introductory rate resets, but we're currently in an environment of higher mortgage rates for longer, so they may not necessarily be able to take advantage of that lower rate when the introductory rate expires. So they have to be ready for all of that when going into a home purchase.

Allie Barefoot: Right, that makes sense. And talking about the money side of it—you know, personal spending and then talking with your banker—that now brings us to our final tier in the ladder, which is just the physical home itself. And this is where 59% of buyers, they found this to be one of the hardest bars to cross here. How willing are buyers to compromise on location, on square footage, or condition of the home itself just to be able to enter that market?

Dr. Selma Hepp: Yeah, you know, buyers often time will not admit that at the beginning of the home search process. They don't want to widen the radius or accept that longer commute or even buy a home that needs renovation. But, you know, when buyers are budget constrained and we're facing the higher cost environment that we're facing at the moment, that often does lead to a wider search radius, longer commute; they may consider a townhome or a condominium instead of single-family detached home; they can reduce square footage or even take that renovation that they were not initially planning on. You know, but the home really is the last and the hardest compromise because buyers view it not just as a long-term asset, but setting their daily life. So that 59% figure is meaningful, but it exposes that supply constraint, right? Downsizing expectations only helps if smaller, lower-priced homes that may need renovation do exist. In many markets, entry-level inventory is very, very thin, so buyers can want to make every intended sacrifice, but still find no viable property. You know, at that point, the binding constraint is not willingness, it's really actually product availability.

Allie Barefoot: And when we're talking about buyers willing to bend and not necessarily break, what does this dynamic necessarily tell us about the long-term housing market demand and price stability moving forward?

Dr. Selma Hepp: Yeah, I mean, we're definitely in a very challenging environment. You know, given the level of unaffordability that we have, we were expecting a much more significant reset to home prices, but we haven't seen that. So there's, you know, a lot going on. One is that the underlying demand is quite durable, particularly among these younger households who can, you know, achieve homeownership at some point. You know, but the demand has also been very uneven. You know, some buyers have delayed rather than disappeared, and we talked about all these other things that they've been doing. But the fact that they still have, to some extent, remained in the market has supported price stability, especially when supply remains tight, and that's really what provided a floor under home prices. But by the same token, that doesn't guarantee broad price growth. Markets with rising inventory, with weakening labor market conditions, with high ownership costs can still see softening home prices. So as a result, we have seen this greater regional and segment-level divergence: resilient prices in markets that are more scarce supply-wise, and more negotiating power for buyers where inventory has rebuilt, and then also continued pressure for entry-level homes.

Allie Barefoot: Right, that makes perfect sense. And my last question here for you, Selma—this has been a great conversation to have with you. I kind of want to look at the ladder as a whole and kind of look at all the tiers together. With 69% cutting lifestyle, 65% adjusting loans, and 59% really compromising on that physical structure, how long can this continue? How long will buyers have to remain on the Sacrifice Ladder?

Dr. Selma Hepp: Yeah, you know, buyers can only remain on the ladder as long as their incomes, their savings, and their confidence can absorb the tradeoffs. The first rungs are already showing strain because households have faced several years of high prices and borrowing costs. Meaningful relief can come from several places, for example: lower mortgage rates (really difficult at this point), stronger income growth (a little bit more likely), more entry-level supply (also a little bit more likely), slower home price appreciation (we are already there), lower taxes and insurance costs (depends on the market, but we're also making progress in that direction alone). So rates alone do not have to return to pre-pandemic lows. The cross-market survey suggests that buyers have practically different triggering points at which they would re-enter. But until affordability improves, the market is really likely to remain slower and more selective, with pent-up demand accumulating rather than vanishing. The risk is really that the prolonged period of sacrifice widens the divide between households with equity or family support and first-time buyers without either.

Allie Barefoot: Yeah, it feels like there is almost this domino effect where whenever it's right for you is the best time to enter into that market. Unfortunately, like you said, you know, the market's not the same in every city, in every county, and every state, but it's also not the same for every homebuyer. So figuring out what works best for you to save up, to cut lifestyle spending, and to talk with your banker, your lender, and really figure out, is this the house I want to live in? There's a lot of different factors that go into that, which our survey does show. So thank you so much, Selma, for breaking this down, breaking down this data, and just kind of giving us another overlooking view at all of this.

Dr. Selma Hepp: Yeah, well, thanks so much for having me. But you perfectly summarized the whole sentiment of this survey: it really depends from person to person, from household to household.

Allie Barefoot: Well, we'll just have to keep reading the monthly Home Price Index report, keep up with the data that Cotality does produce to help people get into the market and figure out what's best for them. But thank you again, Selma.

Dr. Selma Hepp: Thank you.

Allie Barefoot: Thank you again to Dr. Selma Hepp for joining me here on Data in Context, and thank you so much for listening. If you haven't already, subscribe to Cotality's YouTube channel, and as always, if you want to find out more information, head on over to cotality.com.