PrintThe housing recovery has been modest at best even though home affordability is hovering near record levels. Housing is more affordable today because of historically low mortgage rates and falling home values. But affordability measures have become less relevant in today’s real estate marketplace.
The National Association of Realtors’ affordability index was 158.5 in July, down from the all time record high of 178.8 posted in April but substantially higher than a 107.6 index posted in 2006 , a 115.8 index posted in 2007 and a 134.9 index posted in 2008. The affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home. A typical home is defined as the national median-priced, existing single-family home. The typical family is defined as one earning the median family income as reported by the U.S. Census Bureau.
So with home prices falling and mortgage rates near historic lows and the affordability index near record highs, why isn’t a healthy demand for home buying driving the recovery?
In a paradoxical way, falling home prices are inhibiting home buying rather than spurring home purchases. As home values fall, households are postponing purchasing in anticipation that home values will fall further. No one wants to acquire an asset as it is losing value.
In addition, a significant portion of home sales today are foreclosures. Foreclosures are selling at discount prices, bringing the average price of homes downward. Not everyone wants to purchase a foreclosed property because the property could be left in poor condition. This means that some of the price decline is not attracting some buyers who are looking to purchase a primary residence.
Another measure that has made affordability measures less relevant is mortgage rates. Mortgage rates are currently historically low but yet are not enticing enough buyers to the marketplace. Massive job losses and weak consumer confidence are to blame. The unemployment rate is approaching 10 percent indicating that some households simply do not have the financial wherewithal to purchase homes no matter how low mortgage rates fall.
Furthermore, there are a significant number of households who want to purchase a home because of low mortgage rates but are not able to obtain a mortgage loan because of tighter underwriting restrictions. Tight credit conditions are making it very difficult for first-time home buyers to purchase homes. Tighter credit is also making it difficult for homeowners to trade up to purchase larger homes because they may not have enough equity in their homes to qualify for a larger mortgage loan due to falling home values. The $8,000 home purchase tax credit has been effective in enticing some households to purchase homes but that credit is expiring December 1.
Eroding consumer confidence is also keeping households from purchasing homes. Consumer confidence fell dramatically throughout the recession and only recently has shown some modest gains. Consumers are nervous about the economy and job situation and hesitant about spending money. Households with low confidence are not going to be purchasing the big ticket items like homes and automobiles unless there are incentives (government subsidies) to do so.
Finally, lost wealth is keeping households from purchasing homes. According to most stock indices, stock values have plummeted almost 40 percent, while home values have fallen about 31 percent (according to the Case-Shiller home price index). Lost wealth has motivated households to save more of their income, cutting back on goods and services purchases. Lost wealth has also made it more difficult to raise a sufficient amount of funds for the down payment, keeping some households from obtaining mortgage loans.
It is unfortunate that most households are not able to take advantage of favorable affordability conditions for home buying. As a result, the housing recovery will be modest at best. It will take some time for falling home values to steady and for households to rebuild their balance sheets.
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