Housing Affordability Is Plunging Even With Relatively Minor Rate Increases
As shown in Chart 1, the National Association of Realtors’ index of housing affordability fell in April to its lowest level since October 1991. In April of this year, the effective composite interest rate (i.e., a blended interest rate, including fees, on fixed-rate and adjustable-rate loans for the purchase of previously-occupied homes) was 5.92%. Back in October 1991, this mortgage interest rate was 9.02% -- 310 basis points or 52 percentage points higher.
Chart 1
Chart 2 shows that the housing affordability index hit a recent high of 142.5 in March 2004. Thus, at its April 2005 level of 121.9, it has fallen by 14.5% from its recent high. In March 2004, the effective mortgage interest rate used in calculating the affordability index stood at 5.48%. The April 2005 mortgage rate of 5.92% is 8 percent higher than it was in March 2004. Based on a linear regression relating the percentage change in the effective mortgage interest rate to the percentage change in the housing affordability index, an 8 percentage point change in the interest rate should have resulted in only a 6.1 percentage point change in the affordability index vs. the actual affordability change of 14.5%.
Chart 2
Why is the housing affordability index today with a mortgage rate of 5.92% at about the same level it was at in October 2001 when the mortgage rate was 300 basis points higher? Why has housing affordability fallen more of late than what historically would have been expected given the percentage change in the mortgage rate? Because the price of residential real estate has risen to record highs both in absolute terms as well as relative to disposable personal income. Fresh flow-of-funds data released by the Fed show (in Chart 3) that the market value of residential real estate is now at a record high of 198% of disposable personal income. Although the year-over-year percent change in the market value of residential real estate has been great in recent quarters, the changes have not been of record magnitudes. But real estate prices have been outpacing after-tax income growth. Given that housing affordability already is plunging with only minor increases in mortgage interest rates, what would happen to affordability if interest rates were to spike up a hundred basis points or so? Does Alan Greenspan want to find out in the remaining months of his tenure?
Chart 3
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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