Would you borrow money for 30 years if the cost of the loan was 7% or 8% per year?

That’s the question many home buyers and existing homeowners are being forced to answer. The answer may be a combination of math problem and lifestyle preference.

Here are a few housing trends we think are worth watching.

(Prefer video? Scroll to the bottom to watch!)

AFFORDABILITY: AT AN ALL-TIME LOW

Each month the National Association of Realtors publishes affordability data, called their Housing Affordability Index. Per their website, it “measures whether or not a typical family earns enough income to qualify for a mortgage loan on a typical home at the national and regional levels based on the most recent price and income data.”

A reading of 100 suggests the typical family earns exactly enough to qualify for a mortgage on the median home.

Look at the chart below. The index was well above 100 for all of the 2010s, which makes sense. 30-year mortgage rates were between 3% and 5% for nearly all of that decade. Incomes, on average, were more than enough to qualify for the median home loan.

Mortgage rates have jumped to over 7%. What does that mean for affordability?

A general rule of thumb is home debt should account for no more than 28% of pre-tax income. The Affordability Index above uses 25% for its calculation.

Here is an example, with the following assumptions:

• $500,000 home

• 20% downpayment

• 30-year term

• $7,500 in annual property tax and home insurance

A family needs $50,000 in additional income, or a 50% raise, to afford the same home.

Here is a basic mortgage calculator if you’d like to change these assumptions and see their impact on affordability.

SUPPLY: NON-EXISTENT EXISTING HOMES

From 2019 through 2021, over $6 trillion in home loans were refinanced at ultra-low rates. The chart on the left below shows the spike during COVID. The darker green represents refinancing.

Cheap money has many homeowners feeling trapped. The number of existing single-family homes for sale is just under 1,000,000, down a full 15% from the same period last year and down over 40% compared to five years ago, in July 2018. So far, this lack of supply has helped prevent prices from significantly falling.

Personally, I’d need an extremely compelling reason to walk away from my current mortgage rate and move. Zillow just reported half of buyers surveyed between April and July were first-time homeowners, further evidence existing owners are staying put.

Meanwhile, demand for housing has remained resilient in the face of rising rates. With existing supply depressed, new construction is attempting to fill the void. The Wall Street Journal recently reported the share of single-family home sales that were new construction is near an all-time high, at about 30%. Following the global financial crisis, new homes accounted for only 6% of sales, but new homes have typically been between 10% and 20% of single-family sales.

Investors are taking notice. The iShares US Home Construction ETF (ITB), which is concentrated in residential homebuilders and companies serving that market, is up nearly 40% so far in 2023. Warren Buffet’s Berkshire Hathaway invested over $800 million in home builders during the second quarter of this year as well. Time will tell, but the interest rate backdrop could provide a tailwind for builders for quite a while.

RATES: COULD THEY STAY HIGH?

Last year, as rates were climbing, we heard calls from some “influencers” to buy the big house now and refinance next year when rates fall! It’s a heck of a plan, until rates don’t fall.

This may be easier to suggest in hindsight, but a different approach makes much more sense to us. Don’t buy more than you can afford. And unless you are a cash buyer, interest rates and affordability clearly go hand-in-hand.

The direction of interest rates is notoriously difficult to predict. Sure, rates were extremely low through the 2010s and early 2020s. And maybe we do go back to the days of sub-3% mortgages. But I wouldn’t bet my family’s home on it.

It turns out we (consumers) may not be entitled to cheap money and low rates. Just as I listened to my parents’ stories of 17% mortgages, my kids may be hearing about my (low) rate until they’re well into their 30s. Bank of America just suggested a 5% world may become the new norm. If that’s the case, I feel sorry for my kids already.

Interested in talking more? Email me at eric@divviwealth.com or set up time with the Divvi team to continue the conversations.

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