The rise and fall of the starter home - why millennials are choosing to rent instead of own

Flickr / Addison Place at Boca Raton

Young people, the target market for starter homes, are not buying starter homes at the same rates as past generations.

• Starter homes used to be seen as a great way for young people to stop paying monthly rent, build equity, and save up for a larger home.
• Millennials are choosing to rent for longer periods of time before buying larger homes later on - skipping starter homes entirely.
• We looked at the rise and fall of the starter home in the US.
• Visit Business Insider's homepage for more stories.

Buying a house for the first time is one of the greatest milestones of life, but being able to afford your dream home isn't always easy when you're just starting out.

Enter the starter home.

Starter homes are described by Bankrate as small, single-family homes that only require a small down payment and a mortgage. These homes could also be classified as "fixer-uppers," but this isn't necessarily the case for everyone.

Starter homes used to be seen as a great way for young people to stop spending money on rent, earn equity, and enter the housing market at a lower cost before buying a larger, more expensive home later on. However, recent reports have revealed that starter homes are not the great investment many people thought they were. In fact, some experts argue they may be a complete waste of money.

Read more: Why a starter home is one of the worst mistakes a new home buyer can make

Public opinion of the housing market is at an all-time low among millennials. According to a 2018 study by Value Insured, a mere 61% of millennials believe buying a house is more beneficial than renting - that's a 22% decrease since 2016. Only 38% of millennials believe buying a home is a good investment, largely because they think home prices are too high.

So, how exactly did affordable starter homes suddenly become not so affordable?

The rise of starter homes

Starter homes were once touted as a way for young people to enter the housing market and stop spending money on rent with no return. Starter homes gained a reputation for providing young people or couples with the opportunity to gain equity by buying a smaller house at a low price. Many members of Generation X and the baby-boom generation were attracted to this idea.

However, this fairy tale has since come crashing down.

Experts are also reminding homebuyers that in order to build equity, you have to stay in the home for a certain number of years. Millennials are finding that when they do inevitably want to move on from their first house, they haven't gained as much equity as they assumed they would.

"The median house price is roughly $200,000," Ben Carlson of Ritholtz Wealth Management told Business Insider's Libby Kane in 2016. "And for the sake of argument, let's say you don't put anything down. If you stayed there for five years with a 4% interest rate on a 30-year fixed mortgage, two-thirds of your payments go to interest costs alone. You don't build up a ton of equity."

Solis Images/Shutterstock

Only 61% of millennials believe buying a house is more beneficial than renting - a 22% decrease since 2016.

Affordable starter homes are disappearing

Not only are starter homes not guaranteed to build equity, but they are becoming increasingly expensive. A 2018 report by Bloomberg found that the average price of starter homes in the US had hit a record high. Bloomberg reported that homebuyers needed "23% of their income to afford a typical entry-level home" in 2018, up from 21% the previous year.

Starter homes are getting more and more expensive - to the point where many young people feel it's better to continue renting. Student Loan Hero previously reported that homes are 39% more expensive than they were 40 years ago, widening the gap between what young people of yesteryear could afford and what millennials can afford today.

Millennials are renting longer and buying bigger homes later in life

Young people, the target market for starter homes, are simply not buying starter homes at the same rates as past generations.

Members of Generation X and the baby-boom generation could afford to buy small homes at younger ages, and later move on to bigger, more expensive homes. Millennials are finding themselves without the same opportunity. Increasing student loan debt and high daily expenses are preventing millennials from buying a house in their 20s and 30s. Instead, more millennials are choosing to rent longer.

Lifestyle is also a factor affecting the way millennials purchase housing. Millennials are getting married later in life, according to a report by The New York Times. Starter homes are mostly marketed towards young married couples looking to grow their family, and that demographic is shrinking.

According to CityLab, young people also overwhelmingly prefer living in cities. This often involves renting apartments and potentially splitting the rent with a partner long before buying a house together. When couples eventually do shack up together, it's in much more expensive homes compared to past generations, according to an article by Business Insider's Hillary Hoffower.

Owners of starter homes are experiencing buyer's remorse

According to a recent poll of about 1,500 homeowners from Bankrate, roughly 63% of millennials have regrets about purchasing their current home.

The biggest reason for buyer's remorse among millennial homeowners was unforeseen costs associated with their home. When buying a house for the first time, couples may feel inclined to go for the smaller, slightly cheaper option, or even take on a fixer-upper to cut costs. However, the money you save at signing may come back to bite you in the end.

Starter homes may have worked for young couples years ago. However, in today's housing market where both renters and homeowners are paying exponentially more for housing, starter homes are becoming obsolete. Not only do young people think buying a home isn't a great investment, but the actual price of once-affordable homes is rising. Millennials are choosing to rent instead of own, in the hopes of saving their pennies for a larger home down the line.

One thing is for sure - starter homes are becoming less desirable among their target market.

• Read more:
• Starter homes haven't cost this much in over a decade
• A Wharton professor explains why you shouldn't consider buying a home an investment
• Rich millennials are buying vacation homes before starter homes. There are 3 things you should consider before buying one, says a financial expert.
• Millennials are making 3 key decisions that are wiping out the starter home - and it's changing what homeownership in America looks like