Breaking Down the Drivers of Home Affordability

By June 1, 2022 No Comments

The cost of living is going up. The Bureau of Labor Statistics’ (BLS) April Consumer Price Index (CPI) rose 8.3% over the past year, higher than consensus estimates. From food, to energy, cars and shelter, no sector is safe from inflation.

Higher prices doesn’t always mean less affordable, relatively speaking. The Housing Affordability Index (HAI) measures whether or not a typical family earns enough income to qualify for a mortgage loan on a typical home at the national and regional levels based on the most recent price and income data.

It’s significant in projecting demand, particularly in real estate. When homes are affordable, more people will be more likely to buy them. Unfortunately for buyers, homes are becoming less and less affordable. According to the National Association of Realtors, the National Home Affordability Index has fallen to 124.0, down from 175.2 as of March 2021. As of March 31, 2021, the typical family could qualify for a mortgage on a home worth 175.2% higher than the typical house costs. As of March 31, 2022, that number dropped to 124.0%.

For some context, in 2005, near the peak of the last major housing boom, the HAI was 113.2 according to the NAR.

The HAI is derived using Median Home Values, National Mortgage Rates and Median Family Income. All else equal, if you’re making more money, or paying a lower interest rate, homes become more affordable. So how are these metrics changing?

Median Family Income

Nationwide median family income has risen approximately 10.6% since 2019 from $80.1 thousand to $89.4 thousand, approximately 3.5% annually. The level of increase in the face of the COVID-19 pandemic is significant. Two years ago we were experiencing widespread economic shutdowns that threatened the employment of millions of Americans. We saw a tremendous response from industries pivoting and ultimately the impact to family income was not as significant as many expected.

Asset Values and Inflation

Supply chain disruptions and shortages drastically impacted the supply of consumer goods ranging from lumber to computer chips. The end result was, of course, substantial inflation and home price appreciation. Median home values have risen approximately 39.1% since 2019 from $274.6 thousand to $382.0 thousand, approximately 13.0% annually.

Starting to piece the puzzle together, when asset values increase faster than income, assets become less affordable.

To make matters worse, inflation outside of home prices mean that families are spending more for other goods and services, too. The result is that even less of your take-home income is available to put towards a mortgage payment.

 Interest Rates

Income is up. That’s good. Home values and other goods and services are up. That’s bad. What’s also bad is that The Fed’s response to rising inflation is to increase interest rates, directly impacting home affordability. Mortgage rates in 2019 were at 4.04% prior to falling to 2.89% in September 2021. Interest rates have increased dramatically in 2022 to 4.24% as of March 2022, the date in which the most recent HAI was released. National rates have risen to 5.48% as of May 2022, driving affordability even lower.

Recently, home values began their most precipitous increase in October 2021 when interest rates bottomed out. Rapidly increasing rates have the opposite impact. Take this example:

National Northeast Midwest South West
 Current Payment                 1,502               1,564              1,076              1,367              2,054
 +100 bps Payment                 1,686               1,756              1,208              1,535              2,306
 +200 bps Payment                 1,880               1,958              1,347              1,711              2,571
 +300 bps Payment                 2,083               2,169              1,493              1,896              2,849
 Current Affordability Index                 124.0               135.1              170.6              124.6                 97.1
 +100 bps Affordability Index                 110.5               120.4              151.9              111.0                 86.5
 +200 bps Affordability Index                   99.1               107.9              136.3                 99.5                 77.6
 +300 bps Affordability Index                   89.4                  97.4              123.0                 89.8                 70.0
 Current Median Home Value            382,000           397,900          273,800          347,800          522,500
 +100 bps Median Home Value            340,288           354,452          243,903          309,822          465,446
 +200 bps Median Home Value            305,166           317,868          218,729          277,845          417,406
 +300 bps Median Home Value            275,419           286,883          197,408          250,761          376,718

To summarize, a family could purchase a median-level priced home ($382,000) in the March 2022 interest rate environment with a monthly payment of $1,502. However, that payment would only be enough to purchase a $275,419 home if interest rates were increased by 300 bps, a decrease of $106,581 or 27.9%.

Other Considerations

Certainly, the sensitivity analysis on interest rates and the decrease in purchasing power illustrated in the above table does not occur in a vacuum. Market forces will react once interest rates go up, and the factors of supply and demand are dynamic across different rate levels. For instance, if rates increase as modeled above, it is likely that demand for mortgages will go down, particularly in the refinance market, thus dragging down prices and increasing purchasing power.

On the other hand, the increased rates may also encourage people considering a move to stay put in their current fixed rate mortgages, limiting the supply of properties, and pushing prices higher. Such market forces would somewhat offset each other, but would also affect the numbers reported in the chart above if built into the model.

The example above illustrates why it is important for Credit Unions to understand how economic fluctuations affect home values. 

By understanding how interest rates and household incomes affect home values, and how home values affect the balance sheet, a Credit Union can more efficiently allocate assets and mitigate risks.

Dan Price, CPA CFA


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