All this week, we will be looking at the Housing Recovery meme, challenging the assumptions and data that make up that argument. Yesterday, we began with Debunking the Housing Recovery Story (Part 1 of 5). Today we look at exactly how affordable homes are today, as well as the home buying public’s ability to afford them (Home Affordability/Employment & Wages).
Today, we are going to take a closer look at Home Affordability — and we learn that homes are not in fact very affordable at all.
We begin where nearly every other conversation about home affordability seems to start — with the National Association of Realtors (NAR) Home Affordability Index.
We first looked at this index back in August 2008, in a post appropriately titled NAR Housing Affordability Index is Worthless. Why did I come to such a harsh conclusion?
“The index as presently constructed is utterly worthless. It provides little or no insight into how affordable US Housing actually is . . . As hard as this might be to imagine, it shows that over the course of the biggest run up in housing prices in American history, the Index remained perfectly affordable. Except for one monthly reading of 99.55 in late 2005 — a smidge below 100 — housing never dipped into the level of unaffordable over the entire giant housing boom.”
So the entire run up preceding a 35% drop in prices, the NAR HAI had but one month where homes where not deemed affordable. As ridiculous as that sounds, its even more absurd when we take a look at the NAR methodology:
“The index ignores factors like family savings rates, available cash assets, consumer credit, indebtedness, credit servicing obligations, inflation, income gains, and mortgage availability.”
The kindest thing I can say about the Affordability Index is that it lacks context. Hence, it looks at the wrong things and ignores the important ones. The question is not whether, in the abstract homes are theoretically affordable; Rather, the correct question is whether potential buyers can afford homes. Ignoring this as it does means this is a meaningless metric for assessing the most important question of all when it comes to a US housing recovery: Whether or not people living in America can afford to purchase homes located in the same nation.
Sure, houses in the US are affordable to cash-rich Martians visiting Earth looking for a place closer to the Sun. But, not surprisingly, little green men with lots of cash are not what will be driving any US housing recovery. We can say the same about cash-rich Asians and South Americans (and any Europeans assuming the Euro is still around).
Why does this matter?
In the real world, the home buying process begins with two key financial factors: The potential buyers down payment, and their ability to qualify for a mortgage.
In today’s world, most American families are cash poor and debt rich. They are deleveraging, not saving. They simply do not have the $40,000 that is the standard 20% down payment on the median priced US home.
Those that do have the extra cash must then meet the next hurdle: Qualifying for a mortgage. This means they must have a good credit score, not be carrying too much debt, have a steady income, etc. (Even those that qualify must then make sure that their house appraises at the sale price, but that’s a latter discussion).
Regardless of the fact that homes are off 35% from their peaks, and mortgage interest rates at record lows, buyers have an insurmountable hurdle. For most potential home buyers, the NAR Home Affordability Index is a meaningless data point. Lacking any down payment and having restricted access to available mortgage credit, homes may be theoretically affordable — just not to them . . .
Tomorrow: The problem with Mortgage Rates
NAR Housing Affordability Index is Worthless (August 13th, 2008)
NAR: Methodology for the Housing Affordability Index