Housing Affordability Headwinds to Remain for the Foreseeable Future - 2.22.24
by Ryan Schoen , Sr. Insight Analyst
Quick Hit
It's amazing how quickly things can change. The mortgage rate environment started the year off promising, as 30-year fixed mortgage rates fell to eight-month lows. However, two unexpectedly strong economic reports later (jobs and inflation) and we find ourselves right back where rates averaged over the last quarter of 2023, with rates well into the 7's once again. Couple rates with home prices that refuse to abate, and it means one thing. Expect the same housing affordability headwinds to remain a major issue for potential homebuyers this year. However, just because it's an issue that doesn't mean turn your back and wait for a better opportunity in the future, because recent research suggests this could be the norm for quite some time. So in short, buy now.
Key Points and Stats
Housing Affordability Remains Near Historic Low-Level
According to the National Association of Home Builders (NAHB), only 37.7% of homes sold (new & existing) were affordable for median-income families earning $96,300 annually in 4Q2023. That figure was nearly identical to the 37.4% posted in 3Q2023, which was the lowest reading since NAHB began tracking affordability consistently in 2012.
Three weeks ago, groundhog Phil emerged from his burrow to make his much-anticipated forecast and did NOT see his shadow, which indicates an early spring! If housing affordability indicators were a sign of early spring homebuying season, here's what a collection of possible "weather inspired maps" would reveal around housing affordability headwinds that exist in today's local markets around the country.
The first weather map on our radar displays the housing opportunity index or the share of homes sold during the 4Q23 that were affordable to families earning the area's median income by metro.
The top five most affordable housing markets are:
The top five least affordable housing markets all reside in California:
The second weather map on our radar displays the expected principal and interest payments as a share of the area's median family income to purchase the median-priced home.
California stands out in stark contrast to the other housing markets as families earning the area median income aren't likely to qualify for a mortgage to purchase the median-priced home since principal and interest payments alone will suck up more than 40% of their gross monthly income. Meanwhile, Midwestern homebuyers substantially improve their qualification potential thanks to sufficient cash flow because their share of income dedicated to P&I payments falls below the 20% mark in most of the region's housing markets.
The third weather map on our radar displays each market's annual median family income, which is somewhat surprising since there isn't a substantial difference in median family incomes across the country.
Below we see that the maps color gradient key indicates one standard deviation below or above the median of annual median family income of $77K and $119K, representing a difference of $42K or 55%.
In contrast to the above map on annual median family incomes, the one standard deviation range between the lower and upper end with regards to median home prices has a far greater range of $170K to $581K, representing a larger difference of $411K or 242%.
These drastic differences in markets where families essentially earn the same but are forced to face higher home prices and therefore housing cost burdens mean that where one resides will dictate the ability to achieve homeownership and all the benefits that come along with it. It's likely that families in these cost-burdened markets are likely to encounter a high likelihood of income inequality with haves (owners) and have-nots (renters).
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The final weather map on our radar displays home prices to incomes.
A traditional rule of thumb in residential real estate is to purchase a home that is no more than 2.5 to 3 times your annual household income. However, in today's housing environment, that rule almost certainly must be violated to achieve homeownership. In expensive markets, would-be homebuyers can anticipate housing prices to exceed their incomes by five-fold if they only bring home the area's median income.
Going forward, it's unlikely that these housing affordability issues will come to a resolution anytime soon.
In fact, recent research by the Indiana University Center for Real Estate Studies points to demographic pressure on housing markets currently being at its peak, implying a continued strain on supply that is expected to persist for the next several years. The research goes on to state that a "generational housing bubble is on the horizon" with new housing built now to meet strong demand possibly sitting vacant in a decade when demand reversal will intensify by the mid-2030s as baby boomers finally add their homes to the available housing stock. Newsweek published a post referencing the research in which they interviewed one of the researchers, stating:
For Powell, the upward trend in home prices, now mainly driven by millennials' demand, will continue for the next five to 10 years. "The only break we can get on housing prices is if they build more houses," he said. In the long-term, millennials can expect to be hit by yet another blow. While they are likely to buy homes at a very high price now because of low supply and high demand, when they'll be ready to sell their house in 20 years, they'll likely face a drop in demand in the market, driven by demographic decline, which will cause their properties to lose value.
So, in short, as hard as it might be to stomach, buy now and pay attention as these demographic events unfold for when to sell in the future.
Housing Affordability Shifting the Mortgage Market
The historically low levels of housing affordability are having a major impact on the type of mortgage loans homebuyers are seeking in today's market. FHA loans have gone from 17.6% of the agency mortgage market in May 2022 to 25.2% as of November 2023, representing the highest share since May 2017. The rise in FHA loans is a direct reflection of the determination of first-time homebuyers to achieve homeownership at all costs, in addition to them and repeat homebuyers needing to reach for more flexible guidelines that allow for higher debt-to-income ratios to keep up with rising mortgage rates and home prices.
From an underwriting standpoint, overall risk levels in the FHA space appear to be improving as these more recent FHA borrowers are coming with compensating factors such as higher credit scores and larger downpayments. The national mortgage risk index , which attempts to assess how loans originated in a given month would perform if subjected to the same stress as in the financial crisis that began in 2007, has fallen to its lowest level since September 2016 with a potential 90+ day delinquency rate of 29.5% if history were to repeat.
FHA loans are garnering a lot of the focus since they are being leveraged more often and traditionally known as a product that carries a higher default risk than its peers. Every loan type is experiencing elevated debt-to-income ratio levels at the time of loan origination. Even repeat homebuyers, despite equity from the sale of a home are burdening themselves with restricted cash flow as the share of borrowers with greater than 43% DTI has rocketed from 28.6% in August 2020 to 47.2% in November 2023.
Although historically, credit scores have always been the most important variable in determining credit worthiness and the ability to repay, leading to future loan performance, we appear to be entering into uncharted territory when it comes to debt-to-income ratios. Recent homebuyers in every region throughout the country are saddling up to high monthly mortgage debt.
Can they truly handle it or is this the canary in the coal mine that warrants extra attention?
Insightful, actionable and reality in motion from Ryan Schoen, Sr. Insight Analyst New American Funding ??