Two weeks ago, I said it. Now commentators are saying the same thing on the WSJ op-ed page and on SmartMoney.com (snippets below): house PRICES may still be at historical highs, but house AFFORDABILITY is not, which may mean prices don’t have to fall any farther. The crucial forgotten variable is mortgage rates.
Here’s what I noted two weeks ago:
With a fixed rate 30-year mortgage of 18%, a $2000 monthly payment will buy $132,000 worth of home. Cut the interest rate to 6% and the same $2000 payment will buy $334,000 worth of home.
In terms of affordability, the two homes are totally equivalent. Remember, when you buy a house with a mortgage, your monthly payment has two components: a principal payment to pay down the debt on the total cost of the home AND interest on that debt.
While I agree overall that house prices have to fall, I’ve become skeptical about conclusions drawn from [analyses comparing house PRICES to median income]. The fundamental flaw I see is that it is based on a home’s price, not the total cost of home ownership. Maybe I’m missing something here, but it strikes me as obvious that house prices relative to income were lowest in 1982…interest rates were 18%!
If incomes are stagnating, and they are, then affordability is the key. What percentage of your income is actually being used on a monthly basis to pay for the roof over your head? The two authors I’ve cited use the house affordability argument to claim that the housing market has hit bottom.
But I’m not so sanguine. There are three problems with concluding that home affordability today means house prices have no farther to fall: