Great monthly payment affordability is driving sales

Is buying based on a low monthly payment a good idea? In the past with toxic financing products fouling the market, many buyers used affordability products to borrow much more than they could reasonably afford. Those are the same people who are currently underwater clinging to their loan modifications hoping that prices rise so they can sell before their payments go back up. In general, buying based solely on monthly payment is a path to destruction.

However, in today’s housing market, the monthly payment affordability is based on stable 30-year fixed-rate mortgages. Those loans won’t blow up in the future putting the owner in financial distress. The near record low interest rates we currently enjoy makes the reflated bubble prices relatively affordable on a monthly payment basis — my reports prove that. While it’s possible rising interest rates and stagnant wages in the future may bring resale prices down again, those that lock in the low monthly payment from today’s low interest rates will enjoy a low monthly cost of ownership and can weather any market storm.

I am bullish on buying real estate right now. And I don’t necessarily believe prices will keep going up. I’m not a kool-aid intoxicated appreciation buyer. I don’t believe the magic appreciation fairies will cause boundless appreciation that will fuel a Ponzi lifestyle. I am a cashflow buyer. I would buy today so lock in a relatively low monthly cost of ownership and ignore the future gyrations of resale price. For those of you who think like I do, the window of opportunity is still open. In most communities in Orange County, the cost of ownership relative to rent is still well below historic norms. And despite rapidly rising prices, this condition will likely persist for a few more years.

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Why Housing Affordability Is at Risk

Published: Wednesday, 10 Apr 2013 | 1:27 PM ET — By: Diana Olick — CNBC Real Estate Reporter

Homes are more affordable now than they have been in decades, but that could turn more quickly than expected, because the affordability is based entirely on mortgage rates.

How likely is a sudden rise in mortgage rates?

Home prices are actually rising faster than expected, but the gains are being masked for buyers by historically low rates. These rates allowed U.S. homeowners to pay almost 37 percent less in monthly mortgage payments at the end of last year than pre-housing–bubble norms, according to a new report from online real estate portal, Zillow. This as homes today cost 14.5 percent more compared to historic averages, relative to median incomes.

Zillow’s analysis is showing the same thing mine is. Payment affordability is better today than before the bubble. Compared to the bubble itself, payments are less than half.

(Notice that the cost of ownership from the bottom chart hasn’t risen nearly as steeply as home prices have since the bottom last year.)

The average rate on the 30-year fixed mortgage dropped to 3.68 percent last week, according to the Mortgage Bankers Association. From 1985 through 1999, rates ranged from 6 to 13 percent. Present low rates have allowed buyers to purchase more expensive homes, and the mortgage payment is taking less out of their monthly paychecks.

Back in the mid-eighties and nineties, Americans spent nearly 20 percent of their median monthly incomes on their home loans—compared to just 12.5 percent today, according to Zillow.

If this set of circumstances were to persist, it would be a great boon to the economy. If people spend 7.5% less of their income on housing, they have that much more to spend on other goods and services.

The trouble is that wages have either stagnated or dropped at the same time that home values are rising. Pre-bubble, U.S. homebuyers spent 2.6 times their median annual incomes on the purchase price of a typical home, but now they are spending three times their incomes—meaning homes are 14.5 percent more expensive relative to income, according to Zillow.

If wages remain stagnant — and they probably will — the impetus for future appreciation is simply not there. We won’t have a market supported by unstable affordability products in the future because most of those were recently banned. Buying for appreciation is a fools game, and those that are motivated by that today will likely be disappointed.

That is all made possible by government-subsidized, record low rates.

The days of historically high levels of housing affordability are numbered,” said Zillow Chief Economist Stan Humphries. “Current affordability is almost entirely dependent on low interest rates, and there’s no doubt that rates will begin to rise in the next few years.”

I never like how realtors create false urgency with buyers. Mostly, they bullshit their way through any objections and manipulate potential buyers will dubious data or rosy market outlooks. However, there are times when some urgency to act is appropriate. This is one of those times.

Rates will rise because the Federal Reserve will inevitably have to get out of the business of buying agency mortgage-backed securities, which currently drives down rates. This won’t happen immediately, but it will in the next two to three years.

That will directly affect home buying demand, because without dramatic income growth, potential first-time buyers will see monthly payments as too big of a chunk to pay. Meanwhile potential move-up buyers will not want to let go of their fixed low rates, and that will be a disincentive to move.

Homeowners in 24 of the 30 largest metros covered by Zillow were paying more for homes at the end of 2012 relative to their region’s median income than they were from 1985 through 1999. That is a clear red flag that should rates rise, even a few percentage points, home purchases and purchasing power, will fall.

As purchasing power falls or prices rise, the window of opportunity to lock in a below normal monthly cost of ownership will vanish. If interest rates rise far enough, sales volumes will plummet again, inventory will remain depleted because many will still be underwater, and prices may endure a slow, grinding decline. Anyone buying today should consider that possibility carefully because it could happen. People with short-term ownership horizons probably shouldn’t buy because they may find themselves trapped in an underwater home. Perhaps if their cost of ownership is low enough, they can rent out the property and move on with their lives, but their down payment will be trapped until prices rise again.

In the past, I have always been an advocate of large down payments. I still believe 20% down payments should be the norm because large down payments provide market stability. However, in today’s market of super low interest rates and possible future downward pressure, I advocate minimal down payments. Don’t tie up more money in a property than you have to. If inflation does rear its ugly head in the future, having a fixed-rate mortgage at 3.5% will be very beneficial. In my opinion, the best financing option available today is the 5% down conventional mortgage. It has much lower mortgage insurance costs than an FHA mortgage, and it can be paid up front so it doesn’t impact monthly payment affordability.

There’s no question that the monthly payment affordability is driving current sales. Sure, some kool aid intoxication is at work, but when payment affordability motivates someone like me, it is also motivating others who recognize that locking in a low monthly cost of ownership has significant benefit.