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Housing market affordability lowest since 1985

First time?

Chart R

The news on Wednesday that the Fed would leave interest rates unchanged, only the second pause since embarking on a rate-hiking campaign in March 2022, may offer little relief for prospective first-time home buyers reading this newsletter. That’s because the economy has dealt you a pretty rough hand, with the combination of soaring mortgage rates and stubbornly high house prices creating one of the most unaffordable markets in decades.

Indeed, the National Association of Realtors' housing affordability index has dropped to 87.8, the lowest it’s been in nearly four decades. For some perspective, a reading of 100 indicates that a median-income family would have precisely enough to purchase a median-priced home on a 30-year fixed mortgage. As recently as 2021, the same index showed affordability at ~175.

Hoarded up

With mortgage rates through the roof — most quotes are now north of 7% — current homeowners aren’t in a rush to up sticks and move, as those who secured mortgages during the era of ultra-low interest rates are understandably reluctant to re-enter the market. Simultaneously, home builders are increasingly hesitant about new construction projects, with concerns about who can purchase a new home with a 7%+ mortgage, resulting in a monthly drop of 11.3% in housing starts in August.

Why America's housing crisis has hit a new inflection point

Neil Irwin, author of Axios Macro

When an immovable force meets an unstoppable object, bad things tend to ensue. That is what is happening right now in the U.S. housing market, with homebuilders stuck in the middle.

Why it matters: The immovable force is the millions of millennials hitting their prime child-rearing years and looking for a place to live. The unstoppable object is the Federal Reserve, determined to bring inflation down using the main arrow in its quiver: interest rates.

The standoff is creating a housing affordability crisis. Builders are faced with the dilemma of whether to construct houses that buyers may need help to afford, given 7%+ mortgage rates, or to hold back and therefore make long-term housing supply issues worse.

Driving the news: New data out Tuesday morning showed housing starts in August fell 11.3% from July. That was disproportionately driven by a drop in multifamily units like apartments and condos, but starts of single-family homes fell by 4.3%, too.

Builders started work on new single-family homes at a 941,000 annual rate in August, which is 16% below the average pace of construction from mid-2020 to mid-2022.

That aligns with a survey out Monday from the National Association of Home Builders showing a steep decline in builders' confidence.

What they're saying: "High mortgage rates are clearly taking a toll on builder confidence and consumer demand, as a growing number of buyers are electing to defer a home purchase until long-term rates move lower," Robert Dietz, NAHB's chief economist, said in the release.

State of play: The spike in mortgage rates that began in early 2022 took the edge off of home prices — but it was short-lived. In June, the S&P/Case-Shiller national home price index reversed a short-lived dip in home prices, essentially returning to its all-time high from a year earlier (it was 0.02% lower, if you want to be pedantic).

It reflects geographically driven demand, paired with constrained supply.

The peak year for births in the ultra-large millennial generation, as Taylor Swift might tell you, was 1989. That cohort turns 34 this year, an age at which marriage and child-rearing tend to coincide with high demand for square footage.

By the numbers: It adds up to an affordability crisis. Imagine a house that cost $500,000 two years ago and a family taking out a mortgage for 80% of the purchase price. At the then-national average 30-year fixed mortgage rate of 2.86%, the monthly payment would have been $1,656.

A 13.5% run-up in home prices since then (the national average per the Case-Shiller index) would push that home's price to $568,000. A surge in rates to 7.18% last week thus results in a monthly payment of $3,077 for the same house.

The bottom line: The broken housing market right now shows a downside of relying so heavily on interest rate policy to guide the economy.

The only solution is more supply, but it won't be forthcoming as long as homebuilders are skittish about rates and affordability.

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