A number of important economic indicators are pointing to a looming storm on the horizon for the housing market. Subprime lending is once again on the rise, eerily similar to the market conditions that were present in 2008, and the affordability of mortgages is decreasing.
These two factors have some industry experts nervously looking for a way to batten down the hatches. Part of the reason for their concern stems from the fact that home buyers in the U.S. now have to use a higher percentage of their income to pay for a mortgage than they have in six years, according to data compiled by Zillow. This amounts to the average home buyer spending 15.8 percent of his or her income to pay for a mortgage, as of the close of the fourth quarter of 2016.
What is troubling is that mortgage interest rates have started to increase, and many forecasts predict there will be up to three more increases this year alone.
When coupled with the rapid appreciation in the housing market and the overall stagnation in wage growth, the result could be a rapid decline in the affordability of the average mortgage.
Is the sky falling?
Not exactly, considering the current portion of income that is necessary to purchase a median-priced home is still relatively low, especially in comparison to the years that brought about the latest housing crisis. Even compared to housing market periods that have been characterized as normal - such as from 1985-2000, when it was necessary for an individual to allocate between 20 and 25 percent of income toward a mortgage - the percentage of income required is still relatively low.
An uptick in mortgage interest rates that may seem small or inconsequential on the surface can exert a profound impact over the long-term, however. If mortgage interest rates continue to rise as expected and home values continue increasing at their current pace, it’s likely that mortgage affordability will rapidly decline.
The fact that mortgage payments grew much faster than household incomes did over the past year is another troubling factor. Household incomes grew by just 2.2 percent from the fourth quarter of 2015 to the fourth quarter of 2016, while mortgage payments on a median-priced home grew by 9.9 percent over the same data period.
If home values rise and interest rates continue on an upward trend, it becomes inevitable that some buyers will be outpaced by the appreciation, get frustrated about the higher prices and decreased affordability and hold off on their decision to purchase.
As affordability drops, it impacts sellers who are looking to move up, as well, since most are in a situation where they will have to finance their next home.
All of this can add up to a perfect storm of economic conditions, in which the housing market stagnates. When there are no more buyers and the housing market inventory reaches a certain level, home prices suddenly drop substantially and an economic downturn typically corresponds.
There are a number of additional factors that indicate the potential for a housing market slowdown: