Housing Bottom Pickers Cite Affordability, But Do They Really Know What It Means?

Affordability has recently been used as one of the strongest argument for a bullish housing outlook.  In my opinion, it is just the reverse, affordability is one of the most negative headwinds facing housing today. Allow me to state my case.

Many indicators are meaningless on their own. For example, is 6% a high or a low interest rate for a 30 year fixed rate mortgage? The 6% number as such is totally meaningless. However, if one had been able to obtain it during the Volcker years when mortgage rates were oscillating around 13%, then 6% would be absolutely fantastic. On the other hand, if one is used to paying less than 4%, then 6% would appear to be prohibitively expensive.

Affordability in the broader sense is no different. It is not the present situation as such that determines bull or bear market in real estate, it is the coming change from the present situation.

There are three components that determine housing affordability: income, price and interest.

Affordability improves if incomes go up, prices come down and/or interest rates decline. It is a rather quite simple calculation on the face of it. Therefore, if housing has indeed bottomed and home prices are about to rise, the only way that affordability can remain the same is if incomes  rise and/or interest rates decline. 

Since there is no sign that wages are likely to go up a whole lot in the near future, the only way home prices can rise without affecting affordability is for interest rate to decline further. How much further would rates have to decline to raise prices? Bernanke has spent trillions in an effort to drive rates down to current levels, so how much more would Bernanke have to print in order for this to have a noticeable effect?

Home prices can also go up if affordability goes down, if buyers are willing and able to pay higher prices and qualify for a higher loan amounts. There is a very interesting piece of data that is worth watching in this context, from a recent DQNews press release: (this is pertaining to California):


„The typical mortgage payment that home buyers committed themselves to paying last month was $901. That was up slightly from January's $893, which was the lowest since $882 in February 1999. Adjusted for inflation, last month's typical payment was 59.8 percent below the 1989 peak of the prior real estate cycle, and 67.4 percent below the 2006 peak of the current cycle.“


This is the present situation: a $901 payment per month equals a $188,000 loan at 4%.

This was the situation at the February 1999 low: $882/month equaled a $136,000 loan at 6.34%, which was approximately the prevailing mortgage rate at the time.

In other words, over the last 13 years, California's home buyers/mortgage borrowers have increased their average loan amount by 38.2%, while the mortgage payment only increased by 2.15%.

One could conclude from this, all else equal, that if not for Greenspan's and Bernanke's monetary pumping and 'QE' operations and if mortgage rates had stayed at 6 3/4%, home prices in California would be just 2.15% higher today than they were in 1999, unadjusted for inflation.

I personally draw the conclusion that affordability has actually been pushed to its very limits. Any improvement would have to come from even lower interest rates. I further expect to see the current flurry of activity in housing to fizzle out over the next couple of months as there simply is no purchasing power to drive up prices.



Wages and salaries divided by CPI, a rough approximation of 'real wages' – these haven't really gone anywhere over the past few years, which seems unlikely to change in the near future. 



Addendum: The „Dream“ Is Alive and Well, The Dowmpayment is Still MIA

by Pater Tenebrarum


A recent survey of putative home buyers by the Pulte Group had the following results:


Among the top reasons renters indicate they have increased their interest in buying a home include:

lThey like being able to call themselves homeowners (49 percent)

lThey view it as a good financial investment (44 percent)

lThey need more space for their family/kids (36 percent)


The survey also revealed that deterrents – both real and perceived – still persist, preventing some renters from pursuing or achieving the dream of homeownership. The top three reasons indicated by current renters for not purchasing a home sooner include:

lNot enough money for down payment (54 percent)

lThe belief that renting is cheaper than buying (28 percent)

lUncertainty with employment status (23 percent)

"Clearly the dream of homeownership is alive and well in America, yet we still have a ways to go to ensure more renters are able to take that important step towards buying their first home," says Deborah Meyer, senior vice president of Pulte Group. "Homeownership is more attainable than ever with historically low mortgage rates and competitive pricing, as well as affordable new homes designed for first-time home buyers coming into the market.

"We are seeing a renewed sense of optimism, especially from young professionals and young families visiting our communities nationwide," continued Meyer. "In fact, in the first quarter of this year, sales and traffic for our Centex homes, which caters to the value-conscious and first-time buyer, saw a significant improvement over last year – yet another sign of an improving housing market."


(emphasis added)

[We have emphasised the single most important point above, ed.] 

54% think they do not have enough money for down payment, which I take it to mean they live totally hand to mouth and have not a dime in savings, just credit card balances.



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