As an era of low interest mortgage rates appears to be ending and housing prices and interest rates shift steadily higher, many homeowners may find their affordable monthly mortgage payment increasingly difficult to cover.
A prolonged post-recessionary period of low interest rates increased homebuyer purchasing power allowed home prices to rise far beyond levels household income might otherwise allow. The result is a housing market where prices are detached from household income and interest rates – rather than income – are a main driver of economic activity.
Mortgage rates were in a long slow decline prior to the 2007 – 2008 housing market crash which provoked even lower rates. For nearly 10 years afterwards, homebuyers consistently enjoyed mortgage rates well below 5 percent.1
Source: Federal Reserve Bank of St. Louis
Mortgage rates are a primary determinant of housing affordability. By convention, housing is considered affordable when costs are no more than 30 percent of household income. In many Idaho counties, home price data suggests that homes could quickly become unaffordable as mortgage rates rise. As an example, it is instructive to examine the case of Idaho’s largest county, Ada County. According to home price data for 2018 from Zillow Analytics, the median home price in Ada County is $293,700. At current mortgage rates – approximately 4.5 percent – a 30-year fixed rate mortgage for a home at this price would imply a monthly payment of approximately $1,441. Last year, the median income in Ada County was estimated at $60,151. Therefore, an affordable mortgage payment (based on the 30 percent rule) would be $1,504.[1]
At current mortgage rates, therefore, a home at the median price is affordable for a family earning the median income. However, an increase in mortgage rates would very quickly balloon, sending the cost of purchasing a home out of control.
Source: Zillow Analytics, US Census Bureau, Author Calculations
Low mortgage rates increase housing affordability and allow many Idaho households to purchase homes that would be unaffordable at higher rates. This makes Idaho’s housing market potentially vulnerable to monetary policy and rising interest rates. Increases of only one or two percentage points could push many of Idaho’s housing markets well beyond affordability levels.
Idaho’s six largest counties are home to more than 60 percent of the state’s total population. In these counties’ housing markets, home prices with increased interest rates, for the most part, would be unaffordable for a family with a median income attempting to purchase a median-priced home. Prices in Kootenai County are already unaffordable at current interest rates, but an increase in rates also would push the markets in Ada, Canyon and Twin Falls counties over the affordability line very quickly. At 6.5 percent interest rates – the level seen in 2006 prior to the housing crash – Ada, Canyon, Kootenai and Twin Falls counties would all be unaffordable. These four counties combined are home to just under 1 million people.
Source: Zillow Analytics, US Census Bureau, Author Calculations
In Idaho, 13 counties already have median home prices that are considered unaffordable for median income families, but this number would balloon as interest rates rise. This analysis suggests that home prices in Idaho are sustainable only in the current low interest rate environment, and there is a potential for negative price correction as interest rates rise. In the case of a long, slow increase in interest rates, homes in Idaho may not appreciate in value over time. If interest rates reach 6 percent, most Idaho residents would find purchasing a home unaffordable at current prices.
Source: Zillow Analytics, US Census Bureau, Author Calculations
The current prolonged period of low interest rates artificially has, in a sense, increased the affordability of homes and allowed prices to deviate from the long-term equilibrium. Historically, the ratio between home prices and annual income has been roughly 2.6 in the United States, implying that in a typical housing market the median home price would be roughly 2.6 times the median annual household income. In the current low rate environment, however, cheap financing has driven this ratio up significantly. In the United States in 2017 the price to income (P/I) ratio was 3.7. However, 28 counties had more inflated P/I ratios than the national average, including all of the state’s most populous counties, like Ada County (P/I of 4.9), Canyon County (4.6), Kootenai County (5.9) and Twin Falls County (4.0). All counties in Idaho had P/I ratios well above the historical average of 2.6
Source: Median Price Data comes from Zillow Analytics and Median Income data is provided by the American Community Survey.
Prices across Idaho have ventured far above the historical levels relative to income because household purchasing power has been leveraged by low interest rates. This has allowed homeowners to keep their housings costs under control despite the degree to which growth in home prices has outpaced growth in household income. However, the benefits of low interest rates are not manifested in the rental markets. Because renters do not finance their housing costs, they are unable to leverage their purchasing power. As a result, Idaho renters are far more likely to be burdened by housing costs than those who own their homes.
Source: U.S. Census, American Community Survey, Table DP04
In all of Idaho’s counties – with the exception of Power County – at least 20 percent of renting households are burdened by their housing costs, meaning they spend more than 30 percent of their income on housing. In six counties, more than half of renting households are burdened, and in 36 counties at least a third of households are burdened. In contrast, most Idaho homeowners are not rent burdened. In most of Idaho’s counties, fewer than 10 percent of homeowners are burdened by their housing costs, and in only two counties does the share exceed 20 percent.
Idaho’s real estate market has enjoyed a long period of high activity, strong demand and rising prices as the state accommodates a steady flow of new residents. The market has been mutually beneficial to sellers, who can take advantage of high demand and rising prices, and buyers, who find their purchasing power multiplied by low mortgage rates. However, this low-rate fueled boom has caused home prices rapidly to outstrip growth in household income and may imply the potential for a painful price correction if and when interest rates return to the higher levels that prevailed for decades prior to the crash of 2007. As the experience of renters in Idaho shows, the disconnect between housing prices and income is not without downsides; unable to leverage their purchasing power through low mortgage rates, many more Idaho renters find themselves burdened by their housing costs.
After years of low interest rates, Idaho’s home values and household income have become increasingly detached from one another. How and when these two variables will return to equilibrium with each other remains to be seen. Or perhaps, if interest rates remain low for many years to come, Idaho’s housing market has found a new equilibrium.
[1] Assumes 20 percent down and a 30-year fixed rate mortgage.
[2] Median Home Affordability is defined as the percentage above or below the affordability level based on median household income that a 30-year fixed rate mortgage payment would be for a median priced home. For example, Ada County has an affordability level of +10 percent at 6 percent interest rates. This means that, at 6 percent interest, the median home would be 10% above affordability levels for a family earning median income.
[3] Affordability Interest Rate is defined as the interest rate at which the 30-year fixed rate mortgage for a median priced home becomes unaffordable for a family earning median income.
[4] A household is considered burdened by their housing costs when it consumes more than 30 percent of their income. The share of burdened households is provided by the American Community Survey, Table DP04.
Sam.Wolkenhauer@labor.idaho.gov, regional economist
Idaho Department of Labor