If the Worst-Case Scenario Plays Out, This Is What Home Affordability Will Look Like

• In October 2021, national homeowner affordability hit 25% — higher than any month since 2009 and closer to what we saw during the early 2000s.
• Under momentum forecasts, years-to-save could hit 9.3 years by May 2022.
• Under momentum forecasts and a mortgage rate lift to 4.5%, homeowner affordability nationally would stretch beyond 1990s levels to a 29.7% share of income monthly.

The home shopping season is only a few months away, and for the first time in a while, buyers can no longer take record-low interest rates for granted. As rates rise homeowner affordability will be impacted and competition in the market will come down from fierce levels. That in turn means home value appreciation will soften and sales could slow, but by how much is a matter of intense debate.

Forecasts from the major housing research shops for annual appreciation in 2022 range from -2.5% (MBA) to 6% (Corelogic) to 16.4% (Zillow), which is likely due to whether and what mortgage rate expectations are incorporated.

It is my view that the violent appreciation seen over 2021 was a result of investor buyers (of all sizes) rushing to diversify into real estate and single family rent unlocked (for big investors and Wall Street) at the end of the last decade. Households with existing collateral (read: wealthier buyers or existing home owners) also locked in stunningly low mortgage rates — the leveraged investment of a lifetime. And trying to navigate, and win, amid all of those headwinds was one of the largest generations of potential first-time buyers ever. This group likely tried their hardest to move up their timeline to receive crisis-time financing or take an early bet on opportunities unlocked by remote work.

This year will no longer be the early days of a major social experiment in the way we live and work. And with rates back to pre-crisis levels (albeit still low on a historical scale), aggressive early movers looking for some serious leverage will be replaced by those buying for their physical and emotional futures. According to fundamentals and the still high levels of national savings (up 42% from pre-crisis), there will be plenty of those first-time and move-up buyer households left.

But will they be able to access homeownership or be deterred/delayed? One piece of that puzzle is affordability. In past releases, I’ve talked about down payment affordability using a metric I like to call years-to-save. It highlights the challenge for first-time buyers of keeping up with your down payment savings, an effort low interest rates may have actually made harder by inducing extreme appreciation when huge swaths of the workforce still had to sit out of the housing market. While rates remained low, monthly homeowner affordability was more assured despite rapid home price growth. As rates rise, that’s no longer clear and apparent.

I measure monthly homeowner affordability as the share of median household income that would go to principal, interest, insurance, and taxes on the typical home. Using observed data until October 2021, homeowner affordability nationally hit 25% — higher than any month since 2009 and closer to what we saw during the early 2000s.

If home value appreciation keeps up its current momentum (as estimated with simple univariate time series forecasting methods) and rates stay the same (3.56% average for prime borrowers at the time of this analysis), homeowner affordability would top 27.3%. Under the same forecast and considering a mortgage rate almost a full point higher at 4.5%, homeowner affordability nationally would stretch beyond 1990s levels to 29.7%. Using a mortgage rate of 5.5% and the momentum home value forecast, we approach bubble era levels near the one-third of income rule-of-thumb for housing affordability.

Luckily, or rather through the magic of markets, the higher rates rise, and the faster they do it, the more unlikely it is that the momentum home value forecast plays out, very much so because homeowner affordability would be challenged too quickly. This balance of home value appreciation and rising rates will stress test our affordability limits, and potentially push homebuyers away from the for-purchase market.

But nothing happens in a vacuum, so it’s important to look at the alternatives too. And the alternatives are looking rough as well. Single-family rental affordability is eroding. According to the most recent Single Family Rent Index released by Corelogic, single family rents grew 11.5% annually in November 2021. For an apples to apples comparison to home buying, renters must still be investing, so recent volatility in stock markets and lower future expected returns also reduce the appeal of that future.

And finally, the expectations themselves of rates rising above 4 or beyond, could keep the heat on the housing market until they actually do — a rush at a “last chance” to lock in affordability as it stands.