Affordability: Price Declines Offset by Increasing Rates

Affordability: Price Declines Offset by Increasing Rates

Let’s take a look at how affordability is doing in the Seattle area after the last couple months of changes in home prices and interest rates.

So how does affordability look as of January? Roughly the same place it’s been bouncing around since last June. The index inched back up to 103.6 from 100.8 in December. An index level above 100 indicates taht the monthly payment on a median-priced home costs less than 30% of the median household income. The median price was higher in June, but interest rates were lower, so the changes in the two are balancing each other out over the last six or seven months.

King County Affordability Index

I’ve marked where affordability would be if interest rates were at a more sane level of 6%—86.8. That’s not a great level for the affordability index, but it’s far from the worst we’ve seen.

Here’s a look at the index for Snohomish County and Pierce County since 2000:

Snohomish / Pierce County Affordability Index

The affordability index in Snohomish County fell a bit in December but bumped up in January. Affordability in Pierce County has been falling since November.

Tuesday I’ll post updated versions of my charts of the “affordable” home price and income required to afford the median-priced home. Hit the jump for the affordability index methodology, as well as a bonus chart of the affordability index in the outlying Puget Sound counties.

Outer Puget Sound Counties Affordability Index

As a reminder, the affordability index is based on three factors: median single-family home price as reported by the NWMLS, 30-year monthly mortgage rates as reported by the Federal Reserve, and estimated median household income as reported by the Washington State Office of Financial Management.

The historic standard for “affordable” housing is that monthly costs do not exceed 30% of one’s income. Therefore, the formula for the affordability index is as follows:

Affordability Formula

For a more detailed examination of what the affordability index is and what it isn’t, I invite you to read this 2009 post. Or, to calculate your the affordability of your own specific income and home price scenario, check out my Affordability Calculator.

  

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.

6 comments:

  1. 1
    masaba says:

    Hey, Tim, I’m curious, why do you put the, “if rates were 6%” line on these? If rates were ‘at a more sane’ 6% a lot of things would be different in our economy. To start with, higher rates would probably mean higher inflation, wage growth, and a stronger economy in general. In fact, home prices are not very strongly correlated with interest rates at all, strange as it may seem. U.S. home prices have actually seen stronger gains when interest rates are higher. This may seem counterintuitive based on first order effects, but the second order effects of higher interest rates are really what drive home prices, not the interest rate itself.

    http://www.economist.com/blogs/buttonwood/2012/04/house-prices-and-interest-rates

    Basically, if anyone is waiting for rates to rise thinking that home prices will in-turn decrease, they are probably in for a rude shock.

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  2. 2

    RE: masaba @ 1 – I tend to agree with your point, but the reason for the price effect you mention is high rates typically occur during periods of inflation, and if real estate doesn’t keep up it will probably catch up.

    But in defense of Tim, 6% is a fairly normal rate, not one likely to be the result of inflation, and thus not one likely to result in higher house prices due to inflation. And our lower rates are government manufactured rates. If they were market driven, then Tim’s choice of using 6% would seem odd.

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  3. 3
    masaba says:

    The current rates aren’t really as much government driven as they are market driven. Companies and people are sitting on hordes of cash that they want to invest, not spend, thus there is an oversupply of cash and a demand for investments, causing rates to be low. As evidence of this, household debt is at something like a 50 year low and household savings are at one of their highest points in American history. I agree that QE has an affect as well on the current rates, but they have slowed QE a few times and rates haven’t really moved that much.

    Again, I would be leery to make a prediction that when QE ends, rates will spike to 6% and home prices will fall. I’ve heard this prediction many times, and usually, when everyone agrees that something will happen, it doesn’t turn out that way. I’m not saying that it won’t happen (no one can predict the future), but I wouldn’t put a lot of faith in that forecast. For all we know, when QE ends inflation could skyrocket and home prices will skyrocket as well. No way to tell these things for sure.

    I would put more faith in the reality of the current moment, which is interest rates of 4.25% and a reasonable home affordability index. Not an imaginary, albeit saner, 6% situation that will probably never materialize. My guess is that most people on this blog do the same.

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  4. 4

    70% of Economy is Consumer Driven

    Not homes BTW [especially refinancing]; but cars, manufactured goods and services [like eating out].

    With retirees and younger worker investors making like 0% interest on safe investments for consumer purchases, our efforts to keep mortgage interest down is like throwing gasoline on a destroyed economy base fire to put it out…

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  5. 5
    Lo Ball Jones says:

    California cheaper then Seattle and getting more so? Time to flee.

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  6. 6
    Scott Celley says:

    Hi Tim, love your approach to things. Here’s something else for you to consider in your affordability analysis: assumable mortgages. As a result of the Government’s unprecedented participation in the US mortgage market over the last 5 years there are now more than 9 million assumable loans out there (FHA or VA backed), totaling $1.4 trillion in funding. That’s one out of every six mortgages, and far more than ever before in our history. These loans were nearly all written at historically low rates. When these homes sell, buyer’s can assume the existing mortgage and lower interest rate thereby preserving some level of affordability.

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