Increases in home prices and mortgage rates have made sharp cuts to the housing affordability index. The most recent figure is 156. Should it hang at this level, it would mark the lowest affordability in 5 years.
Even with the decline, a housing affordability index figure of around 150 would still mark the 5th most favorable year in 40 years, with the most affordable conditions occurring only in recent prior years. In other words, there are still good market conditions for buyers.
Income rises very slowly. Home prices generally change at a faster pace – both ups and downs. Changes in these variables can therefore impact affordability. However, changes in interest rates have been the principal driver of changes in housing affordability.
It is therefore worth doing a stress test as to where affordability will settle from changing interest rate conditions. When the affordability index hovered at around 120 (measurably lower than the current 156) the housing market was still fine. That is, for the most of the 1990s and early 2000s, the housing market was quite uneventful with no major changes in home prices. For the affordability index to fall to 120, the mortgage rate would need to rise to 7 percent.
When the affordability index touches 100 or lower the housing market faces significant problems. Back in the early 1980s, home sales plunged by more than half. Around 2005 and 2006, a bubble price developed, which then crashed into sharp pains. For the affordability index to fall to 100, the mortgage rate would need to rise to 9 percent.
Currently, mortgage rates in recent months have been bouncing along at 4.3 percent to 4.7 percent. Rates are projected to rise to 5 percent by mid-summer of next year. Maybe 6 percent is in the cards by sometime in 2015. In short, the affordability index does not look like it will plunge to any alarming levels in the next two years.
Lawrence Yun is Chief Economist and Senior Vice President of Research at NAR. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1 million REALTOR® members.