A question rarely asked regarding the housing market today is whether prices are affordable. There seems to be this implicit belief that because prices have fallen so drastically that they somehow must reflect a bargain. This is not necessarily true. I think in our consumerist society people are conditioned to automatically assume that a lower price somehow means a good deal. Go to any mall after the Christmas shopping season and you’ll see “amazing” bargains for 50, 60, or even 70 percent off. But is it really a bargain? This question is not often asked yet this is the central tenet to the housing bubble that got many Americans into trouble.
In order to understand the housing market, we need to look at the income of the average American. Yet this is something that is usually removed from the equation when discussing housing policy. How do Americans pay for their mortgage? From an ever scarcer W-2 job yet Wall Street and policy makers have somehow consciously avoided focusing on this connection because headline unemployment is at 10 percent. But let us look at the relation of income to home prices over the decades:
Source: Visual Economics
Now this is a critically important chart. At the height of the bubble it took 473 percent of the median household income to purchase a median priced home. Compare this to 297 percent in 1975. The current number is 331 percent. But let us run our own numbers based on Census data. The median U.S. household income is $52,029 according to the 2008 Census (this number is lower for 2009 but data won’t be released until September of 2010). The current median home price is $172,600.
Median Household income: $52,029
Median U.S. home price: $172,600
But is this affordable? Not necessarily. First, let us look at the home ownership rate in the U.S.
67.6 percent of U.S. households own their home. The housing situation is very much a majority issue for average Americans. This is where most Americans store their wealth. 51 million households have a mortgage while 23 million live in homes with no mortgage at all (approximately 30 percent). Let us run the numbers for someone looking to buy a home today with a FHA backed loan since this only requires a 3.5 percent down payment. Here are the numbers:
We’ll go ahead and use Texas since there is no state income tax there and it will give a better overall net income to the median income household. After taxes, the family is taking home roughly $3,570 per month. How much money down is need for a FHA backed loan? 3.5 percent and let us use the $172,600 median home price:
Down payment: $6,041
Now if we run the numbers, things look okay here:
$982.60 / $3,570= 27.5% Debt to Income (DTI)
Many bankers will even go with gross income so you will have a better ratio. However, taxes and insurance are other costs associated with owning a home. In Texas, these run anywhere from 2.5 to 3 percent. Let us add that in as well:
PI ($982.6) + TI ($431.5) = $1,414
Now, your housing payment is eating up nearly 40 percent of your income:
$1,414 / $3,570 = 39.6%
What about repairs? Landscaping? Garbage pickup? These are all other items associated with owning a home. Keep in mind we are using the median priced home in our example and not some extravagant home. This is what the average American is facing.
Even going back to 1975, prices would still need to fall to meet that price to income percentage:
$50,029 x 2.97 = $148,586
The median home price would need to fall an additional 13.9 percent to go back to 1975 affordability levels. I’ve seen a few articles mention home prices falling an additional 10 to 15 percent and this seems to fall in line with the above. Keep in mind this is important because buying a home is now based on income and monthly fixed outlays. The maximum leverage products like option ARMs are now a thing of the past. You now have to demonstrate via reportable income that you can afford a home. With unemployment so high this becomes a challenge.
I always find it fascinating that most charts looking at home prices seem only to go back to the 1970s. This is when the U.S. Treasury and Federal Reserve disconnected the dollar from any connection to the gold standard. But let us look at two other periods of relative good economic times, 1950 and 1960:
Median household income: $3,319
Median home price: $7,354
Home price / income = Percent of 221
Median household income: $5,620
Median home price: $11,900
Home price / income = 211 percent
Now this is interesting data. If we use the 1960 ratio home prices today would need to be:
$50,029 x 2.11 = $105,561
A 38.8 percent drop from current levels. The above chart from 1975 to the current housing peak in the late 2000s shows housing prices going up for nearly 30 years. Many average Americans simply assumed this was the normal trajectory of home prices.
But the 1950 to 1960 example shows that after one decade, relative to income, home prices in 1960 were actually cheaper than they were in 1950. In 1960 the median home price cost about twice the median annual household income. Some can’t even imagine this number and think this would be ruinous for the economy. Nonsense from the banking industry. In fact, the 1950s saw some of the best GDP growth:
Now many would argue that the rise of the two income household has pushed home prices up. But you can easily argue that it now takes two incomes merely to have what those in the 1950s and 1960s had. Of course this comes from the insidious ability of the U.S. Treasury and Federal Reserve to siphon off the earning power of average Americans and give massive handouts to the banking industry. And that is exactly what occurs. Look back up at the mortgage calculation chart. Aside from the monthly payment, notice something else? The “cost” of that cheap 5.85 percent mortgage is going to run you $187,176 after 30 years. In other words, the interest you pay is more than the actual home price. Now if banks are borrowing near zero from the Fed why not allow average Americans to borrow directly from the Fed since virtually every mortgage is now guaranteed by the taxpayers? Because interest and fees, unproductive aspects of our economy are being taken from the banking industry and suffocating the balance sheet of average Americans.
Home prices have gotten more expensive because the crony banking system is hungry for more and more profits. If banks had to lend their own money, home prices would automatically adjust lower. Is that necessarily bad? This would provide more mobility and less of a focus on homes as commodities and more as a place of shelter. Take for example the current bust. Say someone in struggling Detroit finds a job in New York but can’t sell his home. Say that new job utilizes their skills more effectively. How is their inability to move helping the overall prosperity of our economy? It isn’t. Yet this is the position millions now find themselves in.
I would argue that homes are still very expensive yet the propaganda is flying from the banking industry because they want people to buy homes even though they can’t afford them. Ironically cheaper home prices would help our economy in the long term but this would cut into additional banking profits since they currently hold over priced real estate, both residential and commercial, and want to off load the waste at peak prices to the taxpayer. The corporatocracy has caused more and more damage to our economy and inflating home prices has been one of the outcomes of giving too much power to the financial sector.
In the 1950s and 1960s when our economy was relatively healthy and booming home prices cost about twice the annual median income. That number sounds about right even for today. Yet the propaganda is strong and many simply want to believe that a big drop in prices means homes are now cheap. Don’t believe it.