With rates rising and home price growth starting to slow, I started to consider how much income is used towards housing in this current economic climate. Mortgage rates are trending upwards to near the highs of 2011 at 4.98 percent, home prices are still rising but at a slower pace, and the median income has been steadily rising although an even more modest pace than house prices. These factors go into how much of a person’s income goes towards housing expenditures and whether housing is a burden for potential homebuyers. This blog will highlight some of the factors and show states and regions where housing is less of a financial burden.
Home Price vs Median Family Incomes
Home prices since 2000 started to outpace incomes but started to turn towards the end of 2007, until home prices plummeted during the Great Recession. In 2008, incomes grew making it favorable for potential homeowners to buy a home. It took home prices about 4 years to recover, beginning in 2012. Around 2014 home price growth began to bloom and once again, prices started to outpace incomes. This pace has continued until recently, as home price growth has slowed making owning a home affordable. As of the second quarter of 2018, family incomes have increased by 52 percent since 2000, while housing prices have increased by 95 percent, or nearly doubled the level in 2000.
Payment to Income and Mortgage Rates
Let us look at the amount of money homeowners had to commit from their income to be able to afford a home. In 2000, when interest rates were 7.90 percent, homeowners had to spend about 19.6 percent of their income to be able to afford a home. In 2006 when rates were around 6.50 percent, homeowners had to spend 22 and up to 24 percent of their income on a home. In the wake of the Great Recession in 2009-2010, mortgage rates started to fall, so the share of income that went to paying a mortgage declined. In 2013 when rates were down to 3.47 percent, the mortgage payment on a median priced home was 11 percent of the median family income, putting less pressure on household incomes. Since that time rates have continued to decline, much to the benefit of potential homeowners. Anything above 30 percent is considered burdensome on households, but below that range would be typically affordable. On a regional level, the West requires a higher portion of your income, which has eclipsed the 35 percent mark. The Midwest, being the most affordable region, requires the least percentage of median family incomes. The Midwest started around 15 percent and, at times, dipped below 10 percent and is currently hovering back around 15 percent.
Payment to Income Ratio
A ratio between 2.5 and 4 is normal and healthy price to income ratio for the housing market. As of August 2018, the median price of existing homes sold was 3.5 percent of the median family income. The Harvard University Joint Center for Housing Studies (JCHS) produced a map showing the US home price to income ratios. The ratios range from under two to over eight. As the map below illustrates, costal markets have much higher ratios, indicating significantly higher home prices compared with incomes. The West Coast region has affordability issues, with several areas posting ratios above eight, including San Diego, Los Angeles and the San Francisco metropolitan area. Small pockets in the Northeast reach above five, mostly clustered around New York City and Boston. The Miami/ South Florida Region also posts low affordability. In comparison, The Midwest region has ratios in the 2-3 range, in line with historical averages.
Jobs Generated vs GDP Growth Rate
The Gross domestic product (GDP) has hovered around 3 percent and has had to withstand the tech bubble, wars and several crises. In 2009, both jobs and GDP took a dive but rebounded the following year. GDP and jobs have grown solidly after the Great Recession. Unemployment has been below 6 percent ever since 2014, which is good for economic progress and potential homebuyers.
Even with rising rates and higher home prices, potential homebuyers have plenty of reason to join the market. Real Estate is still affordable in several states and regions. The job market is strong, GDP is at a healthy level and consumer confidence is high. New homes and existing inventory figures are now improving, although still modestly, but the increase in inventory is helping tame price growth.
Experts forecast that the U.S. economy is in for yet another solid year of strength, albeit not at the same level as in 2017. NAR expects that the mortgage rate for a 30-year fixed mortgage will rise to 4.4 percent in 2018 from 3.9 percent in the last quarter of 2017, an increase of 50 basis points this year. However, how will this change affect the monthly mortgage payment of homebuyers?
It is estimated that, on a 30-year fixed-rate mortgage for $380,000, each half-point increase adds about $100 to the monthly payment. A homebuyer who wants to purchase a home with a value of $380,000 would pay $1,600 every month for the mortgage payment at a 3.9% mortgage rate. Assuming the mortgage rate increases to 4.4%, the buyer would pay $1,700 per month in order to buy the same home.
Among 177 metro areas, we see that 89% of these areas have a median home value lower than $380,000. This means that most homebuyers would see an increase of less than $100 in the monthly mortgage payment. While mortgage rates are still historically low, the expected increase in mortgage rates should not discourage people from buying a house.
We calculated the increase in the monthly payment for 177 metro areas when the mortgage rate increases from 3.9% to 4.4%. As we move to metro areas with higher prices, the dollar amount that is added to the monthly payment rises as well. In Youngstown, OH and Decatur, IL, a typical homebuyer will need to pay an extra $23 every month for a home with a value of $89,000. However, in the San Jose, CA metro area where the median home price is $1.17 million, the monthly payment would increase by $305.
Metro areas with high-priced homes
Depending on the type of homebuyer (first-time or repeat), homebuyers in metro areas with high priced homes may seek a lower priced home or stay longer in their existing home if they already own a house.
First-time homebuyers may look for a lower priced home or a smaller home, one with fewer amenities or a home in a more affordable area with a longer commute. We calculated how much the maximum purchase value would need to be reduced in order to retain the same monthly payment with a higher mortgage rate. For a 50 basis points increase in the mortgage rate, homebuyers need to purchase a home that is about 6% lower in price if they want the same monthly payment as they would pay at a lower rate.
For instance, in San Francisco, CA metro area, the median home value is $900,000. The monthly payment for a typical homebuyer is $3,820 at a 3.9% mortgage rate and a 10% down payment. However, at a 4.4% mortgage rate, the typical homebuyer needs to search for homes with a maximum purchase price of $847,700 to continue paying $3,820. Thus, the maximum purchase price is cut by $52,300. Repeat homebuyer
Rising mortgage rate may push existing owners in these metro areas to stay in their homes longer. Although mortgage rates are still relatively low, some owners may not be able to get the same favorable terms compared to their existing mortgage, especially owners who bought their home in 2012 when mortgage rates reached their lowest level. In the meantime, these owners, who may stay longer in their home, will likely build more equity while home prices continue to grow as a result of the limited inventory. A typical homeowner in San Jose, CA metro area has accumulated $493,000 in equity as a result of the price appreciation in the last five years while the price of his home increased by $165,000 within the last year.
All in all, we see that many homebuyers in most metro areas will not be significantly affected by a higher rate of 4.4%. The visualization below allows you to see how much the monthly payment changes in 177 metro areas when the mortgage rate increases to 4.4% from 3.9%.