Is the Entry-Level Affordability Crunch Real?

In 2017, the median existing home sold in the United States cost approximately $206,250, according to CoreLogic’s public record database, which we view as an appropriate proxy for the entry-level price point. That was 5.3% higher than in 2016, marking the sixth consecutive annual increase. In addition, an approximate 35 basis point increase in mortgage rates compounded the pressure on affordability.

Assuming a typical entry-level buyer financed their purchase with a mortgage under Federal Housing Administration (FHA) terms, which accounted for roughly 40% of first-time originations last year, the average monthly payment for principal, interest and mortgage insurance would have increased 9% in 2017 from 2016. This represented the fourth largest annual increase over the last 28 years and far exceeded income growth in the 2-3% range, raising the concern that the entry-level cohort cannot sustain additional upward pressure on home prices and fears of higher interest rates. Is it possible that the housing recovery could be short-circuited by affordability, even though inventory is incredibly tight and new construction volumes remain below historic norms? Fortunately, we do not believe so.

From our perspective, it is true that income growth and the cost of purchasing a home have to be directly linked over time. But when do you start and stop the clock for comparison points? Over the last five years, our aforementioned monthly payment calculation surpassed income growth four times, with the aggregate annual change in income (2.2%) paling in comparison to the cost of ownership (5.2%).

This is often interpreted as being unfair to the potential entry-level homebuyer, but we do not remember the inverse argument from 2007-12 when homes were becoming more affordable every single year. Over this period, income growth improved by 2.7% per year while the monthly payment dropped by 5.2% per year. And this followed the 1999-06 period when income growth averaged 3.0% versus a 5.9% annual climb in the monthly payment.

The point is that housing and affordability are cyclical and the collective trend is more important than cherry picking instances within a cycle. Consider that if we consolidate the three periods mentioned from 1999-2017, which includes two onerous affordability cycles for entry-level buyers and only one beneficial one, the average annual change in income of 2.7% was easily better than a 2.1% increase in monthly payments. The current monthly payment could increase another 12% before these ratios balanced.

A decline in mortgage rates has clearly aided the calculation over time and offset some of the pressure from home prices, but this is not unique to housing, it is true across the economy as lower financing costs allow investors and companies to buy more with the same amount of leverage. To the degree that financing costs rise, there is a healthy buffer in our analysis to absorb the pressure, and we suspect that it would not occur in a vacuum but more likely alongside stronger income growth, which mitigates the risk further. We are certainly not complacent when it comes to entry-level affordability risk, but as we weigh the outstanding variables, we believe the ability to qualify is still healthy versus historical norms and better than many assume.