No relief in sight: Housing affordability is weakening at the fastest pace in a quarter century

  • Rising home prices, rising mortgage rates and rising demand are colliding with a critical shortage of homes for sale. And all of that is slamming housing affordability.
  • This year, affordability — based on the amount of the monthly mortgage payment — will weaken at the fastest pace in a quarter century, according to researchers at Arch Mortgage Insurance.
  • Other studies that factor in median income also show decreasing affordability because home prices are rising far faster than income growth.

It is the perfect storm: Rising home prices, rising mortgage rates and rising demand are colliding with a critical shortage of homes for sale.

And all of that is slamming housing affordability, which is causing more of today's buyers to overstretch their budgets. This year, affordability — a metric based solely on the amount of the monthly mortgage payment — will weaken at the fastest pace in a quarter century, according to researchers at Arch Mortgage Insurance.

The average mortgage payment, based on the median-priced home, increased by 5 percent in the first quarter of 2018 nationally and could go up another 10 to 15 percent by the end of the year, according to their report.

Researchers looked at the median-priced home, now $250,000, and estimated price gains this year of 5 percent in addition to mortgage rates going from 4 percent to 5 percent on the 30-year fixed. Other studies that factor in median income also show decreasing affordability because home prices are rising far faster than income growth.

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That is a national picture – but all real estate is local, and some markets will see affordability weaken more dramatically. The average monthly payment in Tacoma, Washington, is estimated to increase 25 percent this year, given sharply rising prices. In Baltimore and Boston, it could rise 21 percent in each. Philadelphia, Detroit and Las Vegas could all see 20 percent increases in the average monthly payment.

"If mortgage rates and home prices continue to rise as expected, affordability will get hammered by year-end as demand continues to outstrip supply," said Ralph DeFranco, global chief economist-mortgage services at Arch Capital Services. "A strong U.S. economy combined with a housing shortage in many markets means that there is little hope of any price drop for buyers. Whether someone is looking to upgrade or purchase their first home, the window to buy before rates jump again is probably closing fast."

Barely a decade after home values crashed epically, they are now hovering near their historical peak, accounting for inflation. Prices are being driven by record low inventory of homes for sale. Homebuilders are still producing well below historical norms, and demand for housing is very hot. The economy is stronger, which is giving younger buyers the incentive and the means to buy homes.

Stretching budgets and pushing limits

Maryland real estate agent Theresa Taylor said the supply shortage is hitting buyers hard. She is seeing more clients stretch their budgets to win a deal amid multiple offers.

"People are having to escalate offers on top of rates going up. I'm seeing it in all price ranges," said Taylor, an agent at Keller Williams. "I am seeing it when I'm getting five offers, and people are trying to package up an offer where they're pushing their limits."

Buyers are taking on much higher debt levels today to be able to afford a home. In fact, the share of mortgage borrowers with more than 45 percent of their monthly gross income going to debt payments more than tripled in the second half of last year. Part of that was because Fannie Mae raised that debt-to-income threshold to 50 percent, but clearly there was demand waiting.

"Family income is rising more slowly than home prices and mortgage rates, meaning that the mortgage payment takes a bigger bite out of income for new homebuyers," said Frank Martell, president and CEO of CoreLogic. "CoreLogic's Market Conditions Indicator has identified nearly one-half of the 50 largest metropolitan areas as overvalued. Often buyers are lulled into thinking these high-priced markets will continue, but we find that overvalued markets will tend to have a slowdown in price growth."

CoreLogic considers a market overvalued when home prices are at least 10 percent higher than the long-term, sustainable level. High demand makes the likelihood of a national home price decline very slim, but certain markets could see prices cool if supply grows or if there is a hit to the local economy and local employment.

In any case, the more homebuyers stretch, the more house-poor they become, and the less money they have to spend in the rest of the economy.

With no relief in either inventory or home price appreciation in sight, the housing market is likely to become even more competitive this year.

At some point, however, there will come a breaking point when sales slow, which is already beginning to happen in some cities. Home prices usually lag sales, so if history holds true, price gains should start to ease next year.