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posted on 26 August 2017

How Rising Interest Rates Can Decrease Affordability More Than Home Price Increases

from CoreLogic

-- this post authored by Andrew LePage

Rising home prices and relatively stagnant wage growth have combined to create affordability headwinds for many Americans. Until recently, however, historically low mortgage interest rates have been one of the few tailwinds helping the average homebuyer. But what will happen now that rates are rising again?

One way to measure the impact of inflation, interest rates and home prices on affordability over time is to use something we call the “typical mortgage payment." It’s an interest rate-adjusted monthly payment based on each month’s U.S. median home sale price. It is calculated using Freddie Mac’s average interest rate on a 30-year fixed-rate mortgage with a 20 percent down payment. It does not include taxes or insurance. The typical mortgage payment is a good proxy for affordability because it shows the monthly amount that a borrower would have to qualify for in order to get a mortgage to buy the median-priced U.S. home. When adjusted for inflation, the typical mortgage payment also puts current payments in the proper historical context over time.

The accompanying chart shows that while the typical mortgage payment has trended higher in recent years, it remains significantly below the June 2006 peak on an inflation- and rate-adjusted basis. Going back more than a decade, to June 2006, the inflation-adjusted typical mortgage payment hit a record $1,244, about 47 percent higher than the June 2017 payment. That’s because the average interest rate back in June 2006 was about 6.7 percent, compared with 3.9 percent this June, and the median sale price in June 2006 was $199,900 (or $241,495 in 2017 dollars), compared with $225,000 this June.

The change in the typical mortgage payment over the past year illustrates how it can be misleading to simply focus on the rise in home prices when assessing affordability. For example, in March of this year the median sale price was up 5.9 percent from a year earlier in nominal terms, but the typical mortgage payment was up 12.6 percent because mortgage rates had increased 0.5 percentage points in that 12-month period.

Forecasts from IHS Markit call for mortgage rates, inflation, and income to rise gradually over the next year, and the CoreLogic Home Price Index forecast suggests the median sale price will rise 3.3 percent in real terms. Based on these projections, the inflation-adjusted typical mortgage payment would rise from $848 this June to $983 by June 2018, a 15.9 percent year-over-year gain. Real disposable income is projected to rise about 3.6 percent over the same period, meaning next year’s homebuyers would see a larger chunk of their household budget devoted to their mortgage payments.

©2017 CoreLogic, Inc. All rights reserved.

Source

http://www.corelogic.com/blog/authors/andrew-lepage/2017/08/how-rising-interest-rates-can-decrease-affordability-more-than-home-price-increases.aspx#.WZSERFGGOUk

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