Photo only | Photo only | Getty Images
When mortgage rates hit a 23-year high last week, the cry went out across markets and social media: Is housing affordability dead? Did a version of the American dream – home ownership, children, backyard barbecues – die with it?
The question is urgent as housing affordability has fallen by nearly half since the ultra-low interest rate days of 2021, according to the National Association of Realtors.
According to the association, the average family was already $9,000 short of the income needed to purchase the average existing home as of August, and the recent increase in interest rates since then has put an additional five million U.S. families below the qualifying standard for one, according to John $400,000 loan brought to Burns Real Estate Consulting. With mortgage interest rates of 3%, 50 million households could receive a loan of this size. Now there are 22 million.
While a drop in Treasury yields this week has brought the 30-year fixed-rate mortgage back to slightly below 8%, there is no quick fix.
The qualifying annual income for a median-priced home was $49,680 in 2020. According to NAR, it is now more than $107,000. Redfin puts the figure at $114,627.
“[These are] “Staggering numbers that make home affordability even more difficult for too many American families, especially those looking to buy their first home,” posted bond market expert Mohamed El-Erian, an advisor to Allianz among others, on X.
“It’s a very concerning development for America,” said NAR chief economist Lawrence Yun.
According to Yun, affordability depends on three big numbers: family income, the price of the house and the mortgage interest rate. With incomes rising since 2019, interest rates are the bigger issue. When they were low, they covered up a surge in real estate prices that began in late 2020 and contributed to people moving to places like Florida, Austin, Texas, and Boise, Idaho, to work from their new homes in their old cities . Now the rise in interest rates is eroding affordability, even as incomes rise sharply and property prices largely hold on to the big gains they made during the coronavirus crisis.
“At the current mortgage rate of 8% mortgage payment[s] are 38% of average income,” said Mark Zandi, chief economist at Moody’s Analytics. “The mortgage rate must decrease to 5.5%, or the average home price must decrease by 22%, or the average income must increase by 28%,” or a combination of all three variables.”
At the same time, demand for adjustable-rate mortgages has risen to its highest level in a year due to the overall slowdown in mortgage applications.
What needs to change to make housing affordable again
All three indicators face a difficult road back to “normal,” and there is still a long way to go from here. A few numbers illustrate why.
The National Association of Realtors measures affordability using its 34-year-old Housing Affordability Index (HAI). It calculates how much income the average family needs to have to afford the average existing home, which currently costs about $413,000, according to NAR. If the index is 100, it means that the median family has enough income to buy the home with a 20% down payment. The index assumes that the family wants to pay 25% of their income for principal and interest.
The long-term average of the HAI is 138.1, meaning the median family typically has a 38% cushion. Its all-time high was 213 in 2013 after the housing crisis and the 2008 financial crisis.
This index is currently at 88.7.
Some scenarios using NAR data help illustrate how far affordability is from the average between 1989 and 2019 and what it would take to bring it back into a more typical range, as the 30-year national average fell to 7 on Tuesday .98% fell.
- If house prices remain stable, interest rates will need to fall to 3.55% to return to historical averages.
- If prices rise by 5%, interest rates must fall to 3.16%.
- If prices stay the same but incomes rise by 5%, rates must fall to 3.95%
- A mortgage interest rate that stays around 8% means average home prices will have to fall by 35% to $265,000.
- If interest rates remain at 8% and prices remain at current levels, income must increase by 63%.
But these numbers underscore the challenge of getting affordability back to the levels Americans are used to.
Getting back to the affordability that people enjoyed during the ultra-low interest rates of the pandemic would require even more: The HAI reached an annual average of 169.9 this year, a level that few believe is in will be achieved again in the foreseeable future.
Affordability has been strained in part by home prices rising 38% since 2020, according to NAR, but more importantly has been the rise in average interest rates from 3% in 2021 to as high as 8% last week. That’s a 167% increase, resulting in a $1,199 increase in monthly payments on a newly purchased home, per NAR.
Higher wages are a plus, but not enough
Rising incomes will help, and average family income has increased 16% since 2020 to over $98,000. But that’s not nearly enough to close the affordability gap without putting a higher share of household income toward the mortgage, Zandi said.
Beyond the sheer numbers, the direction of monetary policy will prevent incomes from solving the housing problem, said Doug Duncan, chief economist at Fannie Mae. The Federal Reserve raised interest rates precisely because it believed wages had risen fast enough to fuel post-COVID inflation, Duncan said. Year-over-year wage gains fell to 3.4% in the latest jobs data, he said, and the Fed would like to see lower wage growth.
Downward pressure on house prices would help, but it doesn’t look like they will fall much. And even if housing prices fall, this trend will not be sustainable unless America builds millions of new homes.
After prices soared from 2019 to early 2022, it was easy to expect a major price correction, but that didn’t happen. In most markets, prices have even started to rise slightly. According to the Real Estate Agents Association, the average price of an existing home fell by more than $35,000 at the end of 2022 but has increased by $45,000 since its low point in January.
There is not enough new housing in America
The main reason for this is that there are so few homes for sale that the laws of supply and demand don’t work properly. Even though demand is impacted by affordability issues, buyers out there have to compete for so few homes that prices remain nearly even.
“Boomers are doing what they said they would do. They age in place,” Duncan said. “And Generation X is already locked into 3% mortgages. So it’s up to the builders.”
Homebuilders are kind of a problem, said Redfin chief economist Daryl Fairweather. They have boosted profits this year and BlackRock’s exchange-traded fund, which tracks the industry, is up 41%, but Fairweather said they have barely begun to address a long-term housing shortage that Freddie Mac estimated before the pandemic at 3, 8 million homes estimated, a number that has likely increased since then.
Builders have started work on just 692,000 new single-family homes this year, 1.1 million of which include condos and apartments, she said. So it will take almost four years to build enough houses to restore supply and new households will not be formed, she added. Meanwhile, homebuilding has already begun to slow, and builders are scaling back mortgage buybacks and other tactics they had used to boost demand.
There are reasons to believe that additional buyers could emerge. Duncan said the Millennial generation is now entering the peak period of homebuying, promising to bring millions of potential buyers to the market, with the largest annual birth cohorts reaching the average first-buying age of 36 around 2026. As interest rates rise Fairweather predicts that a drop in mortgage rates will lead to more buyers coming back into the market, but prices will inevitably rise back towards previous highs that mortgage rates had already shown signs of earlier in the year fell to 6% at the beginning of March.
“At this rate we still need a few more years of construction and with high interest rates we cannot sustain demand,” Fairweather said.
The Fed and the bond market are big problems
Economists say there are two problems with mortgage rates right now. One is a Fed determined not to prematurely declare victory over inflation, and the other is an overly sensitive bond market that sees inflation everywhere even though the rate of price increases across the economy has declined significantly.
Mortgage rates are 2 percentage points higher than they were in early March – although trailing 12-month inflation, which higher interest rates theoretically hedge against, has fallen to just 3.1% from 6% in February. That’s still above the Fed’s 2 percent target for core inflation, but a measure of inflation without taking into account housing costs – which the government said rose 7 percent last year, despite declines or much smaller increases of house prices reported by private sources – was 2.1% or less since May.
The Fed has only raised interest rates by three-quarters of a point since then, as part of its “higher for longer” strategy – keeping interest rates higher rather than aggressively raising rates from now on. The main reason for the recent rise in mortgages is the bond market, which drove up 10-year Treasury yields by as much as 47%, or as much as 1.6 percentage points. In addition, the traditional spread between 10-year Treasury bonds and mortgages has widened to more than 3 percentage points – 1.5 to 2 points is the traditional range.
“It’s hard to justify the rise in interest rates, so it could just be volatility,” Fairweather said.
Still, few economists or traders expect the Fed to cut interest rates to support housing. The CME FedWatch tool, which is based on futures prices, predicts that even if the central bank is finished or at least almost finished with its rate hikes, it won’t start cutting rates until next March or May, and then only slightly. And spreads are likely to remain particularly wide until short-term interest rates fall below longer-term Treasury rates, Duncan said.
It could take until 2026 for a “normal” real estate market to emerge
Getting affordability back to comfortable levels will require a combination of higher wages, lower interest rates and stable prices, economists say, and it could take until 2026 or later for that combination to come together.
“The market is at a complete standstill,” Zandi said. “The only way to fix this is through a combination of lower prices, higher incomes and lower rates.”
In some parts of the country, things will be even more difficult, according to NAR. Affordability is even more constrained in markets like New York and California than across the country, and middle-income markets like Phoenix and Tampa are now as unaffordable as parts of California were earlier this year.
Until conditions normalize, the market will be the domain of small groups of people. Cash buyers have an even greater advantage than normal. And if a buyer is willing to move to the Midwest, Yun says, the best deals in the country can be found in places like Louisville, Indianapolis and Chicago, where relatively small price reductions would bring affordability close to long-term national norms. In the meantime there will be drudgery across the country.
“Mortgage rates won’t go back to 3% – we’ll be happy if we get back to 5%,” Yun said.
