posted on 13 September 2016
-- this post authored by Svenja Gudell
For all the talk of income inequality these days, it is America's wealth inequality - which includes assets like a person's home - that is perhaps most striking. The gap between the rich and poor in the U.S. was already wide prior to the Great Recession, and the housing bust and foreclosure crisis that followed only made it worse.
Those wealthier Americans better able to cope with the shock of the housing recession and that managed to avoid foreclosure through the worst of it ended up better off and with even more accumulated wealth at the end of the recession in many areas, according to Zillow's research. At the same time, lower-income Americans that could not avoid foreclosure have missed out on what could have been massive wealth accumulation during the recovery.
To be sure, income inequality is directly tied to wealth inequality, and both have huge implications for the housing market. Home affordability for low-income Americans looking to purchase even a modest entry-level home has suffered enormously in recent years - especially relative to middle- and high-income buyers looking to buy progressively more expensive homes and particularly in hot markets (figure 1).
Nationwide, a buyer earning a median annual salary in the bottom one-third of all incomes and looking to buy a home valued in the bottom one-third of all homes would need to spend 22.7 percent of their income on a mortgage as of Q2 2015, the latest quarter for which data is available. A buyer earning an income in the top one-third and looking to buy a more expensive top-tier home would only spend 11.5 percent of their income on a mortgage. A year earlier, a U.S. buyer at the top would have had to devote 11.7 percent of their income to a mortgage. At the same time, a bottom-tier buyer would have needed to spend 22.5 percent of their income to a mortgage. So while mortgage affordability at the top has improved somewhat, it has actually gotten a bit worse at the bottom.
The differences are more striking at a local level. At the end of 2012 in San Francisco, for example, a potential low-income buyer looking to buy a bottom-tier home could have expected to pay 42.2 percent of their income on a mortgage payment - a stretch, yes, but probably doable. But by Q2 2015, that same buyer looking to purchase the same level of home should have expected to pay 68.4 percent of their income on a mortgage. Over the same period, the share of income a middle-income buyer purchasing a middle-tier home could expect to spend on a mortgage rose from 29.1 percent to 39.8 percent; and from 22 percent to 29.7 percent for a high-income buyer purchasing a high-end home.
Beyond simply rising home prices, which are countered to some extent by incredibly low mortgage interest rates that help keep monthly payments low, much of this gap is directly attributable to flat or very weak income growth for the lowest-paid workers (figure 2). In real terms (after adjusting for inflation), bottom-third incomes have actually declined over the last 15 years, so a larger share of income has to go toward everyday expenses - which have increased with inflation and now cost more than in the past. And this affordability gap says nothing of the availability gap. In many markets, even for those low-income buyers that can find a way to afford a home, there are simply no homes available to buy in their price range.
Realistically, in many markets nationwide, low-income buyers today are essentially getting shut out of the market thanks to this one-two punch of declining inventory and deteriorating affordability.
But only looking at current income imbalances misses the other half of the story. Housing - for millions the largest single contributor to personal wealth - was greatly distorted during the housing boom and bust. During the housing boom, homeownership rates rose from around 65 percent in 2000 to almost 70 percent by 2006, according to the U.S. Census Bureau. A big driver of this increase was a lot of newly minted, low-income homeowners who invested whatever wealth they did have into down payments and mortgage payments.
And when the bubble popped, less-expensive homes - often bought by low-income homeowners - were more likely to be foreclosed on than higher-end homes. Of all homes foreclosed upon nationwide after December 2006 (the national market reached peak in 2007, but many local markets entered the bust portion of the housing bubble much earlier), 46.7 percent were in the bottom-third of all homes in terms of value, compared to only 16.6 percent of foreclosed homes in the top third. This trend holds in many large markets, including Philadelphia, Detroit, San Francisco, Boston, Seattle and Milwaukee to name just a few (figure 3).
This is perhaps unsurprising. Lower-income homeowners are less likely to be able to absorb financial shocks and life curveballs, including loss of employment or unexpected medical costs. And even if they were able to scrape by and keep making payments on their home for a while, the simple fact that they lived in a lower-priced home to begin with lowered their odds of ultimately avoiding foreclosure.
At the outset of the recession, home values for lower-priced homes fell much more dramatically than higher-priced homes, meaning the owners of these homes were also more likely to fall into deep negative equity. And homeowners in negative equity are more likely to be foreclosed upon - especially those in deep negative equity that might see little point in throwing good money after bad just to stay in a home they may realistically have little to no hope of one day selling for a profit.
Foreclosure does more than strip the title of a home away from a homeowner - it also strips away any and all wealth a homeowner had in the home, both invested up front in the form of a down payment and accumulated over time through home value appreciation and built-up equity. When a homeowner put little or no money down, that wealth may have been small or even non-existent. But for those that made even modest down payments - and depending on how expensive a market is, a "modest" down payment is still often tens of thousands of dollars - that wealth was wiped out as part of the foreclosure proceedings.
More importantly, though, homeowners foreclosed-upon during the recession never got to realize the sometimes huge increases in their homes' values during the recovery - and the big gains in wealth that would come with it as home values rise past their initial purchase price. After the national housing market hit bottom, home values started rising quickly again - especially among recently foreclosed, low-tier homes now seen as screaming bargains by investors looking to buy cheap but livable homes and convert them into rentals.
Nationwide, foreclosed homes lost almost 40 percent of their value during the bust, and remain 16 percent below their peak values, despite having risen quite strongly during the recovery (figure 4). The median value of all homes, over the same time, fell roughly 22 percent, and is now 5 percent off peak values. But in some markets, foreclosed home values have recovered all value lost in the recession - and then some. In Denver, for example, foreclosed home values fell by 22 percent, but have since grown by 75 percent since home values bottomed out and are now worth almost 40 percent more than they were during bubble peaks.
If foreclosed homeowners had been able to hold on, they would have been able to see their home's equity - and therefore their wealth - increase. In fact, throughout the entire recovery foreclosed homes showed greater annual appreciation than homes in general, peaking at 12.4 percent in January 2014, and falling to 6.8 percent by April 2016. Overall U.S. home values, over the same time, reached a high of 7.9 percent annual growth in April 2014, with growth slowing to a pace of 4.9 percent by April 2016.
A Source of Anger
There is no small amount of irony in the fact that, after foreclosure, laws prohibited many former homeowners from buying again for seven years, and so millions were forced to rent the exact same kind of homes they had owned only a few years prior. What's more, these homeowners exchanged the relative stability and predictability of a monthly mortgage payment for the instability of rent - which has been rising steadily for years and is becoming increasingly unaffordable.
And there's still more salt to throw on the wound with the benefit of hindsight. It's likely that millions of hardworking Americans found ways to hold on to their homes through the first few years of the recession, only to be foreclosed upon later - which actually turned out worse for them than simply giving the home up in the early years. A homeowner who foreclosed on a home in 2007 would have theoretically been able to buy again in 2014, and may have realized some of the gains in housing of the past few years. But a homeowner that held out desperately only to finally succumb to foreclosure in 2010 or 2011, won't be able to buy again until 2017 or 2018.
This state of affairs has given rise to much of the social anger and instability we see today. The 99 percent movement, the increasing homelessness issue, the ever-contentious presidential election and a growing housing affordability crisis all have roots in this growing divide between rich and poor. We've taken to calling it income inequality, but that only speaks to a small part of the problem. Wealth inequality is incredibly real, is getting worse and is distressingly unheralded. We hope this research helps bring the issue to light.
 Income data is sourced from the American Community Survey (ACS), indexed forward because the ACS series ends several years ago. For median income used in the overall affordability analysis, we chain the income data forward using the Employment Cost Index (ECI), which is updated quarterly with a one quarter lag. But income tier data is not published in ECI. To get tiers, we rely on the Consumer Expenditure Survey (CES), which is published with a one-year lag, which is why our tier data is only available through July 2015 but our overall affordability is available through Q1 2016.
About the Author
Svenja Gudell is Chief Economist at Zillow.
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