Current Housing Affordability Leans On Low Mortgage Rates

By Daniel Duffield

At present, home purchases have become more affordable than during the past several decades, although experts caution that this trend could be reversed abruptly, due to the volatility of mortgage rates and how they play into the current housing trends.

As the housing market gains strength, home prices increases have exceeded analysts’ expectations; however, these gains have been entirely negated for home buyers as a result of the historically low mortgage rates available today. Presently, American homeowners pay approximately 37% less on monthly mortgage payments at the conclusion of 2012 than during the period prior to the bubble burst, according to a report released by Zillow. Surprisingly, however, home prices have risen 14.5% from historic averages, in relation to homebuyer incomes.

While interest rates today hover between 2-5%, rates have ranged between 6% and 13% from 1985 to 1999. Consequently, homebuyers have been able to afford purchases of larger, more expensive properties while paying less each month.

During the aforementioned period during the eighties and nineties, U.S. homeowners spent approximately 20% of their monthly incomes on mortgage payments, significantly more than today’s 12.5% average, according to Zillow.

Although home prices have risen, average U.S. wages have remained stable, being devalued due to inflation, or have declined. Prior to the burst of the housing bubble, homebuyers spent roughly 2.6 times their median annual incomes when purchasing a standard home; however, currently, borrowers spend 3 times their income, making home purchases 14.5% more expensive in relation to income, according to Zillow. This phenomenon essentially results from the historically low mortgage rates created by government subsidies.

According to Zillow Chief Economist Stan Humphries, housing affordability could very well be a short term trend, since current affordability leans heavily on low interest rates that have been predicted to rise over the next several years.

These predictions hinge on the fact that the Federal Reserve must necessarily discontinue its purchasing of mortgage-backed securities (MBS) sometime in the future, the act of which has been the catalyst driving and maintaining today’s low rates. While not immediate, this increase should take place during the next few years.

Once mortgage rates rise, homebuyer demand will be notably affected unless income growth matches this decrease in affordability. Otherwise, potential borrowers (especially first time home buyers) could find themselves unable to afford large mortgage payments, while homeowners will be unwilling to relinquish their exceptionally low rates by moving, instead opting to remain in their current residences.

In 24 of the 30 biggest metropolitan areas covered by Zillow, homeowners paid more for their mortgages at the end of 2012 in relation to the median income of their locale compared to between 1985 and 1999. This provides a warning indicator that, should rates rise even a slight degree, many potential buyers may find themselves unable to afford homeownership.

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