MYM #020: Is Home Affordability the Worst its EVER been?!

By: Fran Walsh

Read Time: 6 minutes

In this edition, we'll delve into the pressing question: Is home affordability the worst it's ever been? Everyone knows how crazy things seem right now, given continuously rising home prices - on top of the highest interest rates we've seen in 20 years! Everyone also has heard one of their family members say "You should have seen what it was like in the 80's!" or something along those lines (lol). All this naturally leads us into today's topic.

Understanding the state of home affordability is crucial for anyone considering a home purchase or investment. It impacts your financial stability and long-term goals.

Homeownership remains a fundamental aspect of the American dream, but rising prices and shifting market dynamics have left many wondering if that dream is slipping away. Let's break down the factors impacting home affordability today.

Key Points:

1. Key Numbers
2. Factors Affecting Affordability
3. What's Next?

Key Numbers

As of today when this is being written (November 1st, 2023) the average 30 year fixed mortgage rate stands at 7.761%. This is the highest it's been since 2000, when it was 8.05% (See chart below.) Given the 20 year trend we have had, obviously rates today seem CRAZY to all younger individuals. However, when you look back into the 80's & 90's, we see that today's rates are actually closer to historical norms rather than what most people who have purchased within the last 10 years have experienced.

When was the the worst year ever for interest rates? As we can see above - in 1981, the average was 16.61%! And that is just the average - according to Mortgage Reports for the week of October 9th, 1981 mortgage rates averaged 18.63% which is the highest rate on record.

Now I know what you are thinking if you are a young individual reading this looking for confirmation bias that now is the worst time ever to buy. You are going to say well it's not all about interest rates! Home prices & interest rates are equally bad! So lets dive into new home price numbers over the years:

For our examples of comparison, let's just use decades when comparing the overall affordability of homes. We'll go with 1980, 1990, 2000, 2010, and today. Obviously when we look at the chart above, you can quickly see how maybe those 12-16% interest rates in the 1980's weren't "disastrous" to the cost of home ownership, given the fact that the average new home was selling for under $100,000. 

Between the 2010-2020 period, rates were relatively low, and new home prices weren't skyrocketing. Obviously that changed greatly post covid, as the average cost of a new home from 2020 to today shot up from just under $400,000 to nearly $530,000 - all while interest rates rapidly rose!

The last piece of the puzzle when it comes to home affordability is naturally average household income. How have these numbers kept up with the cost of buying a new home? Lets take a look.

Median Household Income by Decade:

• 1980 - $16,400
• 1990 - $28,838
• 2010 - $49,578
• 2023 - $74,202

So - when we take a look at all of these numbers (interest rates, home prices, household income) how do each of the examples stack up when it comes to general affordability of a home?

In the above example here is how we laid things out. I took the average new home value from each of the example years we have been discussing. Next we assumed a 20% down payment in each of the scenarios - which gives us our total mortgage amount.

Next we fill in the average interest rate from each of the years we are discussing from our earlier chart above in this blog. Then what we did was assume 1% of the home value for property taxes (around the historical average) & used what little information is out there regarding historical home insurance costs to estimate those. 

Lastly - because we are putting 20% down we are assuming no PMI in any year, no annual HOA's, and lastly let's assume no other debts to keep all else equal. (Though it is worth noting today most people are carrying some sort of debt whether that be student loans, auto, credit cards, etc which obviously impacts what we can afford.)

So - all this to FINALLY get to our main point. Is now the least affordable time to buy a home in history? Let's dive into the final analysis.

Income: (These numbers are Gross - meaning before taxes)

• 1980 - $16,400/year = $1,367/month.
  • $782 monthly mortgage / $1,367 = 57.2% 
• 1990 - $28,838/year = $2,403/month
  • $1,223 monthly mortgage / $2,403 = 50.9%
• 2010 - $49,578/year = $4,312/month
  • $1,444 monthly mortgage / $4,312 = 33.5%
• 2023 - $74,202/year = $6,184/month
  • $3,541 monthly mortgage / $6,184 = 57.2%

As a reminder - when we are talking about housing affordability we like to go by the 28% rule & 36% rule. The 36% rule is the most important one relative to what we are talking about here. Ideally we want our TOTAL debt payments to not exceed 36% of gross income. Most lenders would look at these three examples by today's standards (1980, 1990, and 2023) and would say those "average" households do NOT qualify for that "average" home in each of the given years as they are drastically above that 36% number.

These individuals would either need to have higher income (highlighted in green in above chart) or would need to look at a less expensive house in order to be able to afford it. 

By our calculations above, 1981 is regarded as the most unaffordable time in history to purchase a home. As we have learned today and I'm sure many of you suspected, 2023 finds us in an extremely similar situation with a nearly identical percentage of gross income required for the average household to purchase the average new home at current rates. While rates are lower than they were in 1981, income growth has not kept up with the extreme rise in home prices.

What's Next?

Naturally - upon hearing this, there are usually two schools of thought. One group of people will say "oh wow  now is definitely not the right time to buy let's wait until rates & prices come back down." The other will say " let's buy now because prices are going to keep going up and we can always refinance when rates come back down." 

Who is right? Neither - nobody knows! Could rates & prices simultaneously continue to rise? That is absolutely a possibility. Just because things seem "bad" today doesn't mean it can't get worse! The FED just paused their rate hikes in their November 1st meeting, but that doesn't mean more hikes aren't on the horizon. Could rates come down in the near future? That is also a possibility! However, if the housing market operates as traditionally does, declining rates would traditionally lead to higher home prices. Obviously the last year with both rates & prices rising simultaneously was not normal, but moving forward it's best to operate assuming we will return to some level of normalcy eventually.

Our advice? Very simple. If you are in the market to buy, get something that you KNOW you can afford. Don't buy something and sit there praying rates come back down so you can refinance. Operate on the assumption that whatever your monthly payment all in is going to be, you will be able to afford that relatively stress free for the long term. 

That way, if rates do come back down & you can refinance? Awesome - now you just have more money to save, invest, do home projects, or go have fun with.

Conclusion:

Purchasing a home is as expensive as it has ever been in history in terms of affordability for the average American. If you are getting ready to make that major first purchase, be sure to understand exactly what you are getting into, all of the costs associated, and make sure you aren't stretching yourself too thin. Stick to those 28% & 36% rules that we always talk about!

As much as a house is a major financial decision, it's important to remember that this is going to be your home. Make sure it's something you love & can see yourself in for at least 5 years. We'll dive into the math on why 5 years is important another time!

Actionable Tip:

Don't make any rash decisions as to whether or not to buy a house based on this article. Be sure to do your research, understand all of the numbers behind the specific home you are looking to purchase, and as always - consult your trusted advisor to make sure you feel confident about the decision you are making for your family.