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How To Be Ready if the Housing Market Declines in a Recession
By Aly J. Yale MONEY RESEARCH COLLECTIVE
With the word “recession” cropping up more frequently, concerns for the housing market are rising. Fortunately, there are steps you can take now to protect yourself from an economic downturn and the impact it might have on your home’s value and your future wealth.
Naturally, the strategies you deploy will vary depending on your financial situation and your plans for the coming years, including whether you’re considering (or actively engaged) in selling your home. Additionally, some regions — including the Sacramento area — may be at more risk of a downturn than others, which might mean adjusting those plans as the market changes
While there’s no guarantee the market will head south soon, here are ways you can prepare just in case.
Table of Contents
- Gauge how vulnerable your local housing market is
- House flips and second homes can hurt the market
- Act quickly if you plan to sell your home
- Pay down any high-interest debt
- Build an emergency fund
- Summary of how to prepare for a housing market downturn
Gauge how vulnerable your local housing market is
To start, assess how vulnerable your housing market is, so you can appropriately prepare for what’s to come.
In a recent study, real estate brokerage, Redfin, analyzed a slew of housing and economic data, including migration trends, home flipping volume, price volatility and how quickly the market has cooled to date. It determined that some markets are more vulnerable than others, including Sacramento and various other cities in California, Idaho and Florida. If the area was in high demand in recent years, it’s likely at a higher risk for a downturn.
In Sacramento, growth in housing prices and buyer demand over the last few years are part of the problem. In 2020, home sales were up 23% compared to the year prior, and last year, prices jumped 20% in the area. At one point, Realtor.com even named it the hottest housing market in the country.
But as the old adage goes, “What goes up must come down,” and with mortgage rates nearly double what they were last year, that demand is finally starting to wane.
“There’s been substantial growth in a very short period of time,” says Ryan Lundquist, a Sacramento real estate appraiser and market analyst. “When you look at markets that have experienced growth like Sacramento, it makes sense that they would be contracting because the speed was so fast.”
House flips and second homes can hurt the market
You can also assess local home flipping rates and secondary house purchases, both of which make a market more vulnerable in a downturn. According to Redfin, 5.4% of all Sacramento home sales last year were flipped houses, and 4.3% were second homes.
The expectation is that if the economy were to hit a recession — and these property owners and real estate investors fell on hard times — they’d sell those second homes and investment properties at a steep discount. If that trend became widespread, it would push down home prices marketwide.
“If there’s income loss, then they might get rid of their second home first — try to put it on the market, get it sold and recoup the money,” says Schery Bokhari, a senior economist at Redfin. “So where there’s a bigger presence of these properties, there’s [a] greater risk of the general price level declining.”
Homeowners with high debt-to-income ratios are also more likely to sell at a loss or foreclose in a downturn, thus putting the market at risk. Redfin’s data shows the typical Sacramento homeowner currently has an 81% debt-to-income ratio (DTI) — meaning their mortgage and other debt payments make up 81% of their income.
Act quickly if you plan to sell your home
If selling your home is on your radar, you might want to act sooner rather than later. With potential price declines on the horizon and a slowdown beginning, you could lose out on significant profits and home equity by waiting too long.
“Who knows what’s going to happen three months from now, but the way it’s going, I think the market is correcting itself,” says Waheed Akhtar, a Sacramento real estate agent with RE/MAX Dream Homes. “Waiting might cost you [an] extra 5% or 10% of your equity.”
If you decide to sell, go into it with appropriate expectations. Price the home right, be willing to negotiate with any potential homebuyers, and know that a bidding war might not break out over your property, despite headlines you may have read regarding high prices and competitiveness.
As Renee’ Catricala, a Sacramento real estate agent with Compass, explains, “This isn’t a time for sellers to test the market, but if they’re motivated, realistic in pricing and have an experienced agent representing them, then it’s still a good time to sell.”
Pay down any high-interest debt
As we prepare for the potential real estate market shift and economic recession, it’s a good time to evaluate your financial health. One way to do that is to pay down debt with high interest rates. By targeting this type of debt, you can shrink the amount you owe faster and allocate more money towards saving.
One way to do that is to pay down debts with high interest rates. By targeting this type of debt, you can shrink the amount you owe faster and allocate more money toward savings.
You will also save more in long-term interest by paying down these debts, so if possible, consider making more than just the minimum down payment. You can also put windfalls toward these debts — things like tax refunds, holiday bonuses or even birthday card money.
Build an emergency fund
You should also work toward building a solid emergency fund. If you lose your job or experience other financial hardships that limit your cash flow, this will ensure you can still make your mortgage payments and avoid foreclosure, at least for the short term.
Having an emergency fund also helps you avoid relying on high-interest personal loans and credit cards or dipping into your retirement fund (and paying a steep penalty for it).
The amount of money you should have saved varies from person to person. A general rule of thumb is to have at least three to six months’ worth of living expenses in a high-yield savings account or somewhere else you can easily access it. To avoid temptation, keep these savings separate from the money you use on a daily basis.
If you don’t have this much saved yet, make a plan to build your emergency fund up over time. Being too aggressive could leave you short on cash, which may push you toward credit cards or other costly options to pay your bills.
Summary of how to prepare for a housing market downturn
- With fears of a recession, many people are worried about a housing market downturn.
- According to a report from Redfin, certain housing markets, including Sacramento, are at a higher risk of a downturn than others.
- Many hotspots that saw prices rise rapidly may see home values decline.
- To prepare for a housing market decline, first assess your area’s vulnerability.
- Some things to look out for are whether your area experienced a housing market boom in recent years, if there is a high number of investment properties that were purchased and if homeowners have high debt-to-income ratios.
- If you are seriously considering selling your house soon, do so sooner rather than later to avoid losing home equity if prices go down.
- Paying off high-interest debt can help you prepare your financial portfolio and save money on interest, freeing up more money for emergency savings.
- Build an emergency fund that can help you stay afloat on mortgage payments and other expenses if you lose your job or experience another financial hardship.
- Set aside three to six months of living expenses for your emergency fund and store it in an account that is easy to access, like a high-yield savings account.
