The median home sales price is currently around 4.5x the median household income. That number was 3.5x in 1999 and 3.3x in 1989.
So… case closed? Homes are more expensive than they used to be?
Interest rates are at record lows; they exert a huge influence on mortgage payments, and thus, on home affordability.
Before we look at just how much interest rates impact mortgage payments, let’s look at how home ownership has certainly gotten harder.
The Down Payment
Millions of Americans try to sock away tens of thousands of dollars so they can make a 20% down payment on a home.
Over the past 50 years, it’s gotten much harder to save enough to put 20% down:
In 1970, a 20% down payment on the median home was just 38.9% of the median household income for a year. By 1999, it had soared to 69.7%. By 2019, it was 80.6%.
Not all hope is lost. Prospective home buyers can either take more time to save up for their first homes, or take out private mortgage insurance (PMI). Though PMI can tack on a few hundred dollars to monthly payments (or more), it isn’t permanent and offers a path to earlier home ownership.
Even though saving for a down payment is harder than it used to be, monthly payments are a different story.
Lower Rates Offset Higher Home Prices
My parents bought their house in 1989 for $189,000 and today it is worth around $600,000. It sounds incredible to say, “the value of our home more than tripled in 30 years.” And it’s actually commonplace. The median home was $95,200 in 1989 and is a little over $300,000 today.
But salaries have also increased. Between 1989 and 2019 (the data isn’t yet available for 2020), the median household income has increased 138% to $68,703:
After accounting for inflation, home prices are up 52% over the past 31 years and salaries have barely outpaced inflation. The differing rates are why the aforementioned multiplier has increased.
But at the same time, interest rates have plummeted:
I ran the numbers on mortgage payment affordability across a variety of economic climates:
*Note that the mortgage payment only includes the principal and interest portions. Property taxes, homeowner’s insurance and HOA fees were not included due to geographic differences.
Wow! Seems like homeownership isn’t unattainable.
Although it’s not as bad as many would have you believe, there is more to the story.
Mortgages Aren’t Static
In the previous section, I focused on the initial payment when someone bought a house.
But we’re talking about 30-year mortgages here, and even though the payment stays the same in nominal terms, the affordability changes.
This is where previous generations hold two advantages over the homebuyers of today:
1. Mortgage rates have been in a long-term downtrend since the 1980s.
That homeowner that got a 9.78% mortgage in 1990 was able to refinance their mortgage and pay less than 7% before the end of 1993.
How much further can rates really go down from here? Probably not much. Therefore, today’s homeowner has less downside – which is actually upside – with rates.
2. Inflation may be low for years to come.
One of the great things about a fixed-rate mortgage is that inflation makes it cheaper over time, even though the nominal payment stays the same, assuming your income at least rises by the same percentage as inflation. That can give ownership an edge over renting, as rents often increase by at least the rate of inflation.
However, inflation was very low in the 2010s, and the 2020s may bring more of the same.
Past generations have benefited greatly from high inflation.
In addition to being able to quickly refinance their mortgage, the December 1989 homebuyer watched the value of the dollar decline by 23% from 1989 to 1997.
The January 2012 homebuyer was sitting pretty at first, but has not been able to get a substantially lower interest rate in the past eight years. On top of that, the value of the dollar has decreased by just 12% between 2012 and 2020.
Nobody knows the future, but low inflation – or even deflation – is a good possibility for years to come. That’s bad news for today’s homebuyer.
Square Footage Changes the Equation
If you’re a prospective home buyer, right about now you might be wishing you could travel back in time and buy a house in the 1970s.
But check out these charts first:
Between 1973 and 2019, the median square footage of a newly built home increased by 50.9%.
Between January 1989 and July 2020, the median sales price of a newly built home increased from $113,000 to $330,600. That’s almost a tripling in nominal terms, but a 37.7% gain after inflation. And the square footage increased by 24.4% over the same time horizon!
Granted, this isn’t apples-to-apples data as the square footage data is just for new single-family houses and the sales price data is for all new houses sold. And most of the data in this piece has been on existing single-family homes.
But the trends are clear and the median homebuyer is certainly buying a bigger house in 2020 than in the 1970s or 1980s.
What Does This All Mean?
First of all, don’t trust anyone who looks at one piece of data and claims that homes are more expensive today than at some point in the past; this market is way too complicated for that.
But most important is to not overextend yourself if you’re looking to buy a home in today’s market. Previous generations benefited from improving mortgage payment affordability over time due to lower rates and inflation.
Today’s buyer has fewer sources of upside and should be able to comfortably pay their mortgage from the outset.