CA Affordability Reaches Record Low, $133,000/yr Income Needed to Buy Median Priced Home
The housing affordability index (HAI) for California has tied it's record low set in 1989. Currently only 14% of Californian's can afford to purchase the median priced home in the state which now costs $568,890. This is an extremely telling piece of data in that July of 1989 represented the peak for California housing before seven year bear market took hold.
In July of 1989, the median priced home in California reached $201,653. Ignoring a brief 5 month span in 1991 when prices crept just above that level, home values would not move higher until May of 1998 almost 9 years later.
Experts and economists on the no bubble side of the debate will point to the fact that the California economy went through a period of great suffering and the housing market fallout was a natural by product. This time the market is different because our economy is solid and there is a glut of demand for a limited supply of homes in the state. The affordability issue takes the air out of this argument. If only 14% of people are able to afford homes, there will not be sufficient "able" demand to push prices higher.
A more important difference between the current market and 1989 is the use of adjustable rate and "gimmick" loans. Adjustable rates were used at that time to combat low affordability brought on by high prices AND high rates. We currently have record low rates and people are still turning to ARM's for the slight advantage they offer in terms of lower payments in the short run.
Since the HAI is calculated using a 20% down payment (which is only used by move up buyers who have built equity in a previous residence), a 30 year fixed rate and a maximum debt ration of 25% this understates the current percentage of Californian's who are able to buy homes. As lenders have gotten more aggressive, you can borrow with a payment as high as 55% of your income using an interest only loan or even negative amortization. Further, with a good credit score you can state your income so the ratios are irrelevant.
Such loose lending has caused the current overpriced state of housing. People now buy homes like cars, based on payments. Unfortunately, unlike cars, your obligation is for 30-40 years instead of 3-6. Also, adjustable rates will rise taking the "affordable payment" you qualified with well beyond the comfort zone for many of the more recent home buyers.
In 2006 $82 billion dollars of loans will reset to market rates as their fixed period ends. At this time, the Fed seems intent on raising rates another .75% at a minimum. Short term indices such as the LIBOR, which most hybrid ARM's and interest only loans are based on will rise a similar amount. If 10% of the people holding those $82 billion of loans can't afford that new higher payment we will be looking at $8.2 billion of mortgages worth of homes coming on to the market in the form of quick sales or foreclosures.
When you consider that the entire mortgage market currently exceeds $10 trillion this amount is not significant and can easily be absorbed by the market without a significant hit to prices. BUT, in 2007 a full $1 trillion of mortgages adjust to market rates. Again assuming only 10% of the mortgage holders are not capable of handling the new payments, you have $100 billion dollars of mortgage debt secured homes coming onto the market. This will certainly have a negative impact on the housing markets, especially since the majority of the hybrid ARM's, option ARM's and interest only loans are in higher priced, bubble markets.
We fully expect 2006 to look much like 1990 and 1991 did; essentially flat as the market begins it's transition. However 2007 will be the year that we start to see falling prices. Prepare now while fixed rates are good, lending terms are easy and equity is still abundant.