# Median Home Prices Inch Above “Affordable Home” Price

As promised in last week’s affordability post, here’s an updated look at the “affordable home” price chart.

In this graph I flip the variables in the affordability index calculation around to other sides of the equation to calculate what price home the a family earning the median household income could afford to buy at today’s mortgage rates if they put 20% down and spent 30% of their monthly income.

The “affordable” home price has been dropping dramatically this year thanks to the rapid increase in interest rates. The “affordable” home in King County now sits at \$427,820, with a monthly payment of \$1,708.

Here’s the alternate view on this data, where I flip the numbers around to calculate the household income required to make the median-priced home affordable at today’s mortgage rates, and compare that to actual median household incomes.

As of July, a household would need to earn \$69,300 a year to be able to afford the median-priced \$434,000 home in King County (up from just \$49,732 in January). Meanwhile, the actual median household income is around \$68,000.

If interest rates were 6% (around the pre-bust level), the “affordable” home price would drop down to \$356,064—18% below the current median price of \$434,000, and the income necessary to buy a median-priced home would be \$83,266—22% above the current median income.

At this point if prices keep rising, we’ll be back in serious bubble territory almost immediately. Therefore, I expect home price increases to come to a grinding halt in the second half of 2013.

## About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

## 28 comments:

1. 1
rojo says:

Grinding halt sounds good. How about reversal? Do you see any chances of reversal of gains in the past 12 months?

2. 2
mike says:

Until underwriting standards loosen significantly I don’t see how the housing market is going to enter true ‘bubble’ territory. Of the non-cash buyers I’ve talked to lately, it’s still the case that banks are asking for heaps of financials even from applicants with 20%+ down, low DTI’s and top tier credit scores. The tightly underwritten low fixed rate mortgages and cash buyers that fueled the recent price gains. More importantly these purchases aren’t creating the same kind of ticking time bomb that IO, Negative Amortization, teaser rates and 100%+ LTV lending and to high DTI badly qualified buyers did back in 2006.

Because of this, I’m more convinced that today’s buyers can actually afford their homes, regardless of whether the blanket ‘affordability index’ says things are a hair on the unaffordable side.

3. 3
Plymster says:

RE: mike @ 2 – Tim’s last post was about the FHFA was encouraging loans to people who defaulted LAST YEAR, and you think underwriting standards are “tight”? Wells Fargo’s site lists IO ARMs and 95% LTV mortgages as the norm. Sure, maybe they’re actually requiring documentation (as opposed to the NINJA loans of 2006), but 95% LTV is hardly “tight”.

4. 4
mike says:

RE: Plymster @ 3 – Ultimately it’s all about how they’re underwritten, and whether there are appropriate risk premiums in place to deal with the higher defaults inherent with the risks. The main issue with ‘bubble era’ loans was the risk was layered and obfuscated in a way few people understood. It wasn’t just IO or high ltv that caused the problems, it was when there were 2, 4, 8+ additional risks layered on and no reserves to back up these complicated loan models – and that caused a financial meltdown.

The biggest risk that wasn’t accounted for, especially in subprime, was a protracted downturn, or even a flattening in home values. Subprime, as it was structured in the middle of the last decade was a ponzi scheme absolutely dependent on increasing home values for the loans to be paid back. I don’t get the impression that the risk of price declines is being overlooked in today’s lending the way it was back then.

The other key difference is the number of risk layered loans relative to the market as a whole. When 80%+ of the market is fixed rate loans to well qualified buyers, there’s less chance a small % of poorly performing loans will contaminate the entire market. What we had back in 2006 was a situation where bubble markets were 70%+ dominated by subprime and alternative loan products, most of which had a reset or recast date within 2-5 years – and there was little chance the borrower could refinance out of these products unless prices kept going up or the borrower magically received a big sack of cash.

There’s always going to be a potential for that to happen again, but a handful of ‘affordability’ programs and moderately risk layered loans to well qualified borrowers isn’t a sign that Bubble 2.0 is imminent. If these products start making up 50% of new loans, then yes, it’s probably time to get ready to either sell or cash out everything you can and head for the hills.

5. 5
YOYO says:

I skim this blog 2-3 times a week for the past 3 years.

Regarding Mike’s #2 post: I’m very ignorant with all things RE, but I have to say we bought a house in the 1st Quarter of last year (in SEA). And we had no problems with financing, and we have mediocre credit. And we didn’t put 20% down. Our mortgage is with WF and our APR is 4.5%.

6. 6
David Losh says:

What?

Thanks for all the detailed analysis, but the problem is that loan amounts far exceeded the value of the property.

The way the system works, or used to work, is that if some one defaulted on a loan the property would go to auction, some one would pay a cash price for the house, and the remainder was a loss.

When loan amounts got to be double, or triple, or quadruple the amount anyone would pay cash for at auction the system melted down.

Promise to Pay? Affordability? WTF?

7. 7
nwbackpacker says:

@mike Great points. I sure hope you’re right (especially since we may buy a house soon, lol).

We purchased a house in 2004 and I would say it was about like buying a movie ticket. Just kidding, but it was super easy and didn’t require much financial documentation. That was with a pretty low income and non perfect credit. Now with perfect credit scores, 3x the income and 1/5th the debt, they require almost every piece of financial information imaginable. Good for them but coming from the 2 lending environments, it sure *seems* like banks are doing their due diligence.

RE: The 1 year foreclosure forgiveness thing…that seems a bit suspect :-/

8. 8
Azucar says:
What?

Thanks for all the detailed analysis, but the problem is that loan amounts far exceeded the value of the property.

The way the system works, or used to work, is that if some one defaulted on a loan the property would go to auction, some one would pay a cash price for the house, and the remainder was a loss.

When loan amounts got to be double, or triple, or quadruple the amount anyone would pay cash for at auction the system melted down.

Promise to Pay? Affordability? WTF?

I’m not sure who you are responding to because I don’t think anyone has used the expression “Promise to pay” in the comments.

So you don’t define what the remainder is when you say “and the remainder was a loss”.

I understand it to be the difference between the outstanding loan balance and what is paid for the house at auction. What you overlook is that “remainder” is affected by the amount that someone has paid into the loan (including the down payment and any principal that has been paid off).

Requiring a 20 percent down payment also makes people less likely to walk away from the house if the “value” of the house drops (what they perceive the house to be worth based on looking a similar home in their neighborhood selling). If they’ve bought a house for \$500k and have a \$100K down payment and owe \$400K, they’re not going to walk away from it until the “value” of the house is well below \$400K. If they hadn’t made that \$100K down payment and still owed \$500K on it, they’d be more likely to walk away.

9. 9
Pegasus says:

Sadly everyone, sparing a few, has missed the reality of the real estate market. One has to look at only the change in cash buyers to figure what has happened. Mom and Pop are not the big buyers in the real estate market. They have not returned in droves. Neither have the first time buyers to any great extent despite the recent historic lows in interest rates. The key to reality is the surge in cash buyers. Almost 60 percent of all real estate buyers now are cash buyers, way up from the 30 percent of just a few years ago. This is not Mom and Pop and certainly not first time buyers. The buyers are largely institutions(hedge funds), criminals laundering cash since real estate is still exempt from reporting requirements, flip speculators and wealthy foreign buyers that are likely people that we despise because of their repulsive behavior. Welcome to the new Amerika where Mom and Pop are still broke and the first time buyer is very lucky to find a full time job.

10. 10
drshort says:

RE: Pegasus @ 8

I think a lot of the cash buyers are baby boomers looking for retirement income. They no longer trust the stock market, bonds pay 3% (with high risk of rising rates/crashing prices), and feel the downside asset price risk is low in real estate after the recent correction.

11. 11
Mike says:

RE: Pegasus @ 8 – but are the non-mom and pop cash buyers the ones picking up homes priced near the median? I do look, but I do not see that happening where I’m at. I’ve seen one \$400k town home go to an investor. A bunch of \$350k tear downs go to small builders, but nothing near 60% being sold as non-occupied. Every recent sale in my neighborhood has either gone straight to tear down or people moved in immediately after closing. I check, and I’d notice if over half were going as rentals or sitting empty and unused.

12. 12
Kyle says:

RE: mike @ 4

Great input. Do you know where I could get data on mortgage composition trends?

13. 13
David Losh says:

RE: Azucar @ 7

When I first started as a Real Estate agent in the 1980s more properties were sold by owner contract. The price of property was low.

Some investors would buy the owner contracts for cash, and let the loans mature, or they would be cashed out by sales, or in some cases refinances. The question the buyer of the Note would want answered is if they ever wanted to end up with the property.

In the 1980s property values, the cash price of property, was more closely watched. Underwriting was still tough, you had to show you would be willing to pay, but ultimately the price of the property had to be in line with the money that was being lent. That is why investors needed to put 20% down, but at 20% down a landlord expected the rents to cover the mortgage.

Some properties were worth owning so the rents didn’t cover the mortgage, and the property needed to be “fed” each month to get the property paid for. The investor did have the reasonable expectation that the rate of inflation would catch up the rents to the value.

The 1970s, and 1980s were crazy times of inflation which Paul Volcker crushed by stating to Congress the Federal Reserve would do anything to put an end to it, which included double digit interest rates.

In the 1990s things settled down, but that is when this “Promise to Pay” became the normal for home loans. Complex formulas of income to debt were looked at more closely than the value, the cash value of the property. Banks found that the borrower became the basis of the value of the mortgage, rather than the cash value of the property.

Asset appreciation took over, loans were made at 125% of value, Lending portfolios grew fat with more, and more people wanting to own a piece of the American Dream, and the Secondary Markets for loan portfolios went out of control by 1998.

From 1998 to 2008 I think we here know what went wrong, but we are still playing this game that the borrower is the basis of the loans being made.

The price of property has to come down in order for it to be a viable investment. The only way to do that is for more properties to sell at lower prices. That is really hard to do when people see how much property prices have inflated, and that buyers are willing to pay those prices.

I have no idea really how it will settle down other than this new crop of investors, those buying property, will have to make some sacrifices.

14. 14
corndogs says:

RE: David Losh @ 13 – The thing you fail to realize Losh is that back in 1980 houses that you were trying to sell were only about 2200 sq ft and quite modest by todays standard. After 1980 you’re looking at 2800 sq ft houses which are much more elaborate. In Ballard High School area for instance, houses built prior to 1980 are selling for a median of \$500K while the post 1980 houses are around \$800K. Houses today, in general ARE worth much more, so the median affordability is never going to get to where it was, with the current mix. Not to mention the fact that most Western Washington neighborhoods before 1980 were no where near maximum build out, nor were the laws that regulate building anywhere near as costly as they are today.

As has always been the case, there is affordable housing in the Puget Sound area, if you are willing to live in the old houses or houses far out enough to where there is still plenty of available lots to build. You are living in lala land if you think housing in Seattle proper is selling 2 or 3 times more than its actually worth.

Another thing to keep in mind is that home ownership has reduced back to the pre-Clinton levels. Obamas so called ‘middle class’ is not competing for Seattle mid or high tier housing, they are competing for affordable rental housing. The home owner today is part of a smaller group of more affluent citizens. If the economy improves the Obama folks might qualify to buy something someday, but as is quite evident by todays market, their participation is not needed for a ‘normal’ housing market with continually increasing prices rising with inflation.

All the bubble was is a shake-out of risky unworthy homeowners and little game of musical chairs as the rightful owners took possession of the good properties at excellent financing rates. The crap properties assumed their true worth… This should lead to a much more stable market going fwd. If the government continues to interfere in the future, by supporting BS loans to Obamanites, that just means that we’ll have chances to flip low end houses over and over till the cows come home at the bank and/or taxpayers expense.

The bubble is over, the rebound is over. Welcome to normal. If you’re saving for a house of your own, you better hope your savings are beating inflation because affordability isn’t getting better anytime soon.

15. 15
Erik says:

RE: corndogs @ 14
“All the bubble was is a shake-out of risky unworthy homeowners and little game of musical chairs as the rightful owners took possession of the good properties at excellent financing rates. The crap properties assumed their true worth… This should lead to a much more stable market going fwd. If the government continues to interfere in the future, by supporting BS loans to Obamanites, that just means that we’ll have chances to flip low end houses over and over till the cows come home at the bank and/or taxpayers expense.”

Not sure I have a good property, but it’s a lot nicer than I had in a way better area.
Old Loan: \$212k
New Loan: \$88k

I was able to ride on the back of government loans at 5.25% which isn’t great, but my loan payment with taxes and insurance is \$635/mo.

When I looked at your property it said it was a fannie mae foreclosure so I assumed you got a homepath loan also. Is that true? Because in that case you are also riding the backs of taxpayers, right? Homepath is 5% down and no points or 3% down and points to pay.

16. 16
mike says:

RE: Erik @ 15 – So you took out the 88K loan and then let the 212K loan go to short sale?

17. 17
Erik says:

RE: mike @ 16
No, I had 2 loans and had to let the \$212k one go.

18. 18
Erik says:

RE: Erik @ 17
It was a negative amortization loan that I could no longer afford because my payments had risen. The plan like many other people was to refinance it, but that wasn’t possible and Wells Fargo wouldn’t give me an affordable payment plan.

19. 19
wreckingbull says:

The comedy here is good today. Let’s talk about ‘normal’ after the Fed’s \$85 billion/month of MBS purchases is stopped. Also quite funny talking about ‘normal’ when the government is guaranteeing 95% of mortgages issued. If this is ‘normal’, we are doomed.

20. 20
macDog says:
RE:
The bubble is over, the rebound is over. Welcome to normal. If you’re saving for a house of your own, you better hope your savings are beating inflation because affordability isn’t getting better anytime soon.

Yes, with massive transfer of wealth, I wonder if affordability based on median income matters anymore. Inflation is affecting all of us and will eat the rest of middle class alive if they’re not aware of what really is going on. Rentership grew since the bubble. South Lake Union development and influx of new amazonians with stock options will only push “affordability” and rents further in the coming years for this region. They will be the kind of “new normal” folks to afford to live within Seattle.

21. 21
David Losh says:

The comedy is good, but there is no reason to engage it.

22. 22
doug says:

Affordabilty is an oxymoron a word that is a polar opposite of itself. Whatever someone is willing to pay isnt that what its really all about. The financial markets and media have tricked everyone into believing everything is a-okay so lets get out there and buy those really good deals in real estate or AMZN stock or Gold or a barrel of oil.

Except they are not a good deal its a trick ass con job.

Make no mistake all the cards are in place and teh house is about to fall

23. 23
johnnybigspenda says:

I believe that the argument of affordability based on the median income is not valid. Its all about income distribution and the breakdown of incomes for those who own versus those who rent.

Is there a statistical source showing the median and avg income for renters and for owners?
62% of people in SEA own a home as opposed to renting (per US census data). That leaves 38% who rent. The median income of \$68K includes everyone including those making \$1MM and those making \$10K. The median home price of \$434K does not apply to 100% of the population in SEA. Only the 62% who own. There are also many who own their homes outright which are also affordable those folks.

This measurement of median income versus median price is a relative measure at best. It may show a trend, but it is hard to say if it shows absolute affordability as is being touted.

24. 24
Jonness says:
Let’s talk about ‘normal’ after the Fed’s \$85 billion/month of MBS purchases is stopped.

I’m not sure how the Fed can ever stop breathing for the patient while simultaneously delivering electric shocks to the heart.

The taxpayers are being charged billions of dollars per year by the banks who have a huge amount of cash parked at the Fed drawing interest. The game is, if the cash gets lent out as in a “normal” market, we get high inflation. So the Fed (acting in the interest of taxpayers) will have to pay the banks a high enough interest rate to keep them from lending out the money.

If the banks lend out the money, we don’t get a normal market, and if they continue to rob the tax payers for interest on the money, we don’t get a normal market. So it’s difficult to envision a normal market anytime soon.

The closest we can get to being in a normal market would be if it “seemed” normal as a result of perfectly threading the needle between enough loans being lent to stimulate the market, but enough backing off the throttle to not cause high inflation. But that would have to go on for a very long time, because the excess reserves parked at the bank are sufficiently large enough to present economic danger for quite some time.

Inflationists claim the huge amount of printing that is occurring is resulting in a huge amount of reserves parked at the Fed that will be released into the economy as soon as we start to get inflation (because the Banks won’t want to let inflation ravage the value of their money).

Deflationists cite falling wages, an anemic job market, and a seemingly Japan-like economy as a reason we won’t get inflation any time soon.

At the core of the debate is Copernicus’ famous “Quantity Theory of Money,” from the year 1526, in which he theorized prices vary directly with the supply of money in society. According to him the supply of money is the major determinant of prices. “For prices increase and decrease according to the condition of the money.” “An excessive quantity of money,” he warned, “should be avoided.”

This led to the formula MV=PQ, which states the Money supply times the number of times the money changes hands per year equals the price times the quantity of goods produced that year (I.E. GDP). So when you raise M, it has a pronounced effect on the prices and quantity of goods produced.

Interestingly, M equals the monetary base (MB) divided by excess banks reserves (R). So the formula becomes (MB/R)V=PQ. IOW, increasing the monetary base has no effect as long as the banks park an equal amount of reserves at the Fed instead of lending it to consumers. But as soon as it gets lent out, you get the inflation all the “inflation hawks” are warning us about. To really get this, one must keep in mind that banks are in the business of lending. That’s how they make their money in a “normal” market. :)

It’s an interesting situation that the Fed believes it can control by simply raising the amount of interest it pays on the reserves to always cause the banks to lend at a “healthy” rate. The Fed theorizes it can do this long enough that the huge reserves eventually trickle out into the economy unnoticed. I don’t tend to put a lot of faith in the Fed’s ability to pull this off. At a minimum, the length of time this trickling would require ensures we will not have a “normal” market for about as far as the eye can see. :)

25. 25
Jonness says:
Is there a statistical source showing the median and avg income for renters and for owners?

The 2009 AHS median for owner-occupied units was:

Metro Area: \$83,020
Metro Area moved in past year: \$76,100
Seattle city: \$94,000
King County without Seattle City: \$93,000
Pierce County \$74,000

The median for renter-occupied units was:

Metro area: \$36,000
Metro Area moved in past year: \$33,000
Seattle City: \$34,100
King County without Seattle City: \$35,148
Pierce County \$35,652

Incomes were fairly evenly distributed across renter-occupied units. Incomes for owner-occupied units were weighted more heavily toward the top, with the bulk of the incomes being \$60K and above. Also, the large majority of homeowners who moved in the prior year (purchased a home) fell in the \$60K and above category.

See the AHS for more detail.

26. 26
David Losh says:

RE: Jonness @ 25RE: Jonness @ 24

Wow!

“At the core of the debate is Copernicus’ famous “Quantity Theory of Money,” from the year 1526.”

I’m just going to point out that we have developed a global economy in the past ten years.

All Central Banks who are printing are watching the velocity of money lost on Emerging Market speculation. We have the same here. The money goes dead in assets like housing, which is paying a 6% return.

You could, or I suppose I could, calculate the returns on Emerging Market speculation, but that data is real spotty. I don’t know that we will ever know for certain how much cash has been squirreled away.

The Fed can stop.

27. 27
Jonness says:
I’m just going to point out that we have developed a global economy in the past ten years.

True, but you should keep in mind that those who do not learn from history are doomed to repeat it. IOW, what you allude to is the minority part of the equation. Consumer spending currently represents 71% of U.S. GDP. Therefore, the amount of Money being lent to American consumers has the majority effect on MV=PQ in the U.S.

After just having witnessed the massive housing bubble that occurred when the banks lent like crazy to anyone with a pulse, it shouldn’t come as a surprise to you that if the \$2 trillion currently parked at the Fed gets lent to consumers, it’s going to have a massive affect on prices.

In order to really understand this, you have to realize the banks typically hold perhaps \$100 billion or so (if any at all) in excess reserves. \$2 trillion (and climbing) is a whopping amount of money that has the power to completely devastate the U.S. economy. The Fed is quite literally threading a camel through the eye of a needle here, and there is very little margin for error.

http://research.stlouisfed.org/fred2/series/EXCRESNS

The Fed can stop.

Of course the Fed can stop. But the problem is it won’t. Otherwise, who is going to buy our bonds? And when nobody buys our bonds, the cost of borrowing will double or triple, which will cause the U.S. government to have to default on its debt.

The Fed has to keep buying U.S. debt, or things will get extremely ugly. Thus, the excess reserves will simply go higher and higher, and the problem will get worse and worse until the Fed no longer has the power to control it, at which point everything will burst at the seams.

Yes, I know everybody is screaming about tapering at the Fed, and stopping the printing presses is what everyone is reading about in the newspaper. Thus, 99.9% of people currently believe the Fed will simply stop printing, and all the risk is over. But I’m not talking about today, I’m talking about what’s going to occur after the Fed tapers, the economy slumps, and the Fed is forced to ramp the presses back up to full blast again. Then it’s more of the same ol’ right up until the seams burst.

28. 28
john says:

>>As of July, a household would need to earn \$69,300 a year to be able to afford the median-priced \$434,000 home in King County <<<

What on earth? no household that I know of can afford a \$434,000 home on \$70K a year, that is just nonsense.

Sure the might make the payments but they would require a lot of assets to ensure they did not lose the home at the first bump in the road.

Over the past 20 years people have twisted the number to make stupidly high payments fit the bill.

The first loan I got had a max 3 times primary income and .5 times second income. It protected everyone.

over time it moved to 5 times household imcome which is exactly why millions lost everything when we hit a major bump. Pretending that OVER 5 times income makes any kind of sense is just BS designed to keep the scheme rolling.
(I have a good net worth and could a few homes for cash so I am not some bitter priced out punter)