patrick.net

GoranK says

Do affordability indexes like CS, or others take into account the effect of the lower interest rate

No

Interesting. I didn't think so just after a cursory glance at a description of the CS index.

Do you know of any index that does take into account the interest rate? I think it's important to consider since it is a real cost to any potential buyer.

GoranK says

Do affordability indexes like CS

Case Shiller has a price index, but I don't think it had anything to do with affordability.

Affordability itself is a funny word. It can mean lower prices (for Patrick ;) Debt is slavery) or it can also mean lower interest rates (monthly payment as a reasonable % of the monthly household income). I think the Govt. and the Fed take the latter as the meaning, therefore they are trying their best to keep interest rates as historically low as possible.

If low interest rates are offering price support for houses (because they allow more buyers to come into the market than otherwise), then Case Shiller takes it into account by simply just following prices.

Although Case-Shiller has imperfections such as not accounting REO, investor flips, condo, multi-family etc.

Thanks for the response Uomo.

I'm not following you though on how CS takes into account interest rates by simply following prices.

Looking at prices only is fine, if people buy with all cash.

But a large percentage of buyers finance, and financing has real cost associated with it which include the interest rate. There's a huge difference in monthly outlay when someone has a 7.8% rate vs a 3.875% rate. If the CS doesn't directly account for that, I would like to find a model that does (if it exist).

GoranK says

I'm not following you though on how CS takes into account interest rates by simply following prices.

What I'm saying is -- let's say interest rates were higher; then in a weak economy like today (high unemployment, tepid growth), then prices would fall much further and faster. CS, by virtue of tracking prices will show this quite clearly.

If the prices are not falling too further/faster (which is the case right now, YOY change is about 3.4% decline for the 20-City Composite CS Price Index -- http://www.calculatedriskblog.com/2011/12/case-shiller-house-prices-fall-to-new.html )

=> lower interest rates are helping provide price support.

I see. I guess CS isn't providing what I'm looking for when it comes down to it. If CS is simply a price index, it only accounts for interest rate as it has an effect on prices, but not affordability.

I see a lot of people who post graphs and charts on here, CS being a big one, to prove that buying a home is a fools game compared to pre-bubble prices (mid-90s).

But are people taking into account the effect of how much it cost to finance money compared to the mid-90s too? I don't think most people do.

GoranK says

But are people taking into account the effect of how much it cost to finance money compared to the mid-90s too? I don't think most people do.

Probably they don't.

I think that has to do with the general pessimism about the housing market. Human psychology drives things to extreme (bullish/bearish). We tend to look for things that we wish to see too (confirmation bias).

Here's a recent blog post regarding a) mortgage purchase applications and b) median family income level compared to median family house prices (for conventional financing).

Mind you: the affordability index is published by NAR which wants you to buy more houses, LOL. No conflict of interest right there.

http://scottgrannis.blogspot.com/2011/12/housing-fundamentals-are-starting-to.html

Based on data, I'd say low interest rates are having the required impact (which is to support house prices). May not be significant enough, but that is a reflection on the general state of the economy (which has high structural unemployment, will take a decade or more to fix that).

That's a good article. Thanks for posting.

BTW, for anyone reading, I'm not a housing bear or bull. I think of myself as agnostic when it comes to the market.

For people who buy all cash, I think there is room for prices to drop. But for people who plan to finance a home purchase, it would seem to me that things are looking better, especially in markets where rental parity is possible.

GoranK
You probably want the California Association of Relitters Housing Affordability Index - First-Time Buyer. This was the index they invented after homes became unaffordable using traditional metrics (see CAR HAI-Traditional). Now is a great time to buy -- with an ARM.
BTW, pretty interesting to see the Excel time series for 1989 peak unaffordability and then look what happened in the middle of the last decade.

GoranK, "affordability" is a very interesting topic. Much of it can be interpreted as subjective, although given some generalizations & assumptions, it can be quantitative with caveats. Certainly, one must take all numerical analyses of affordability with a grain of salt since different groups will make different generalizations, often to support their own interests (like an affordability analysis by the NAr).

One very large factor, and one that is pretty hard to work into a quantifiable metric, is consumers' perceptions toward buying real estate. For the past half-century, buying a house was more or less a dogmatic ritual that was performed in the name of financial security & getting a piece of the American Dream lifestyle. I think that a lot of people (or at least more than usual) are starting to see that buying RE is one giant compromise with convincing arguments that it doesn't guarantee a net-gain in financial security or lifestyle improvement over time. It CAN if executed carefully, but even then it might not. With that notion creeping out, people are (thankfully) beginning to question the conventional wisdom of the baby boomer generation when it comes to housing. We live in a different world, with different demographics & we are definitely in a transitional period with our society as it is indisputably growing older (average age of citizenry).

So really, do what you can to find affordability information, but in the end what is "affordable" to you is really a product of your own circumstances. With tighter lending standards appearing (FINALLY), most affordability indices will probably show a drop. Too many people thought, and still think, that "afford = how much can I borrow". For any other consumer good, credit & loans are used to buy things in cases where one cannot AFFORD them. Afford = pay cash.

Because housing became SO unaffordable decades ago, people completely changed their mindset to make housing an exception to the "afford = save & pay cash" definition. This cancerous notion of "credit = affordability" needs to be purged from our society. It probably won't happen, and I think that house prices will continue to slump towards greater affordability as long as loans are made properly difficult to obtain. Without loose lending, the flow of funny money is gone and the market is being forced to bear what the participants can actually contribute (although all the government loans are presently shielding the market from the full force of the broke populace).

Anyway, good thread. Hopefully we can get some more good analyses & discussion on affordability.

@EBGuy:Not sure if I trust the CAR/NAR since they've been known for reporting bad figures, but thanks for the links.

@bmwman91: Good point, I think perception is towards real estate in general in very important. The U.S has a passion for housing. Even with the bubble popping, I'm not sure if that passion has subsided. Maybe for those who could never afford it in the first place, but I think those that can afford it are willing to take the plunge.

I think comparing classic accounting with the Keynesian economy of today is like comparing the sun in our Universe with a hypothetical Sun in an alternate Universe. Using some abstract proof ripped from the pages of Particle physics. It looks slick, but it is for amusement only.

Adjusting for inflation, while not factoring in the APY and the personal savings rate, which has already been factored in for you, is careless IMO.

In 1995, your dollar was worth more as a resource. Not because of the value of the dollar has gone down, but because there is no return on saving your dollars.

Let's look at the Prime rate in 1995.

9.00

http://research.stlouisfed.org/fred2/data/PRIME.txt

Let's look at the saving rate

1995
6.3 - 4.3

http://research.stlouisfed.org/fred2/data/PSAVERT.txt

Savings annual return
1995 5.53

http://swanlowpark.co.uk/bank0604.jsp

Your monthly deposit of $100.00 for 10 years with an interest rate of 5.53% compounded Monthly
with an initial starting balance of $1,000.00

Year Balance
1 $2,289.92
2 $3,654.93
3 $5,099.42
4 $6,628.02
5 $8,245.60
6 $9,957.37
7 $11,768.80
8 $13,685.69
9 $15,714.19
10 $17,860.79
Final Savings Balance: $17,860.79

Read more: Simple savings calculator -- Bankrate.com http://www.bankrate.com/calculators/savings/simple-savings-calculator.aspx#ixzz1j0BLW7kT

Where as now, look at what that same savings schedule with today's rate gets you..

Your monthly deposit of $100.00 for 10 years with an interest rate of 0.70% compounded Monthly
with an initial starting balance of $1,000.00

Year Balance
1 $2,210.92
2 $3,430.36
3 $4,658.40
4 $5,895.09
5 $7,140.49
6 $8,394.67
7 $9,657.68
8 $10,929.59
9 $12,210.46
10 $13,500.35
Final Savings Balance: $13,500.35

Read more: Simple savings calculator -- Bankrate.com http://www.bankrate.com/calculators/savings/simple-savings-calculator.aspx#ixzz1j0CpeaQp

13,000 of that was my own money I would have deposited. At this rate, I make a paltry 500.35 from my prudence.

Look at the 80's during their recession, the prime rate was 1981-04-01 17.00% Money was expensive to borrow, but it was generous to savers. The personal savings rate was 12.2% they were getting 8.90%.

Which means, you would have made more from a Bank in 1981 saving $100,000 for 30 years.

Year Balance
1 $109,676.54
2 $120,289.44
3 $131,929.30
4 $144,695.50
5 $158,697.03
6 $174,053.41
7 $190,895.77
8 $209,367.88
9 $229,627.46
10 $251,847.46
11 $276,217.59
12 $302,945.91
13 $332,260.60
14 $364,411.95
15 $399,674.43
16 $438,349.10
17 $480,766.14
18 $527,287.69
19 $578,310.92
20 $634,271.43
21 $695,646.99
22 $762,961.57
23 $836,789.89
24 $917,762.23
25 $1,006,569.90
26 $1,103,971.08
27 $1,210,797.32
28 $1,327,960.66
29 $1,456,461.36
30 $1,597,396.49
Final Savings Balance: $1,597,396.49

Than the Bank will make from loaning you 550K today at 3.75%

Mortgage Repayment Summary
$2,559.64
Monthly Payment
$921,468.77
Total of 360 Payments
$371,468.77
Total Interest Paid
Dec, 2041
Pay-off Date

Interest paid in a 550,000 Mortgage from 2012 to 2041 $371,000

Interest earned from saving 100,000 from 1981 to 2011 at
8.90%.
$1,497,396.49

Stop factoring in "Inflation" what about the savings deflation.
A little money back then could parley into money that is STILL a nice chunk of change, and by fare a greater return than any of the major indexes have yielded consistently for the last 10 - 20 years.

If banks were in the business of "Banking" and the government would let free market forces work. Then money would earn money, and we would just let the numbers speak for them selves. That is why the Case Schiller index has been relevant, and no one ever thought of inflation adjusted prices before. Because that would have been a huge crock of crap, and would have never flown, when our banking system actually WORKED.

If you ask many peoPle currently lookin to purchase in big metro area California why, they will STILL insist that it's a great investment and they expect to sell in 10 years or less. Obv under this scenario, prices have much more to do with things than interest rates. What good are current low interest rates if you expect a home to be a magic savings account?

I do believe that for some people, the current environment is much more ideal than its been in 8-9 years or so. But you better be sure you're gonna be living there a while.

GoranK says

There's a huge difference in monthly outlay when someone has a 7.8% rate vs a 3.875% rate.

Interest rates have fallen in tandem with price declines.

GoranK says

@EBGuy:Not sure if I trust the CAR/NAR since they've been known for reporting bad figures, but thanks for the links.

@bmwman91: Good point, I think perception is towards real estate in general in very important. The U.S has a passion for housing. Even with the bubble popping, I'm not sure if that passion has subsided. Maybe for those who could never afford it in the first place, but I think those that can afford it are willing to take the plunge.

There's that word again...!

I agree that there is still a lot of The Underpants Gnome profit model in America (South Park reference).

Step 1: Buy a house.
Step 2: ???
Step 3: PROFIT!

This dogmatic attitude has decreased a little, as far as I can tell, but I would agree with someone if they said that it still permeates almost every corner of the US. In places like the SF Bay Area, the irrational exuberance for buying RE is still everywhere. This illogical desire to live here "at any cost" is really irritating. My feelings about it can be summarized by, "you can't compete with stupid." There is a huge pool of "stupid" in the bay area, and that pool of people is keeping prices higher than most people are comfortable with. Being that the Bay Area is home to 16M people or something though, you only need a small percentage of "stupid" in the system to cock it all up! As long as the government is giving out easy money loans to "stupid", I cannot see any good reason to participate in the market with my money. Eventually, the easy money is going to have to be restricted further, and that might be the time that I consider biting the bullet. Shared walls aren't my favorite things in the world!

bmwman91 says

As long as the government is giving out easy money loans to "stupid", I cannot see any good reason to participate in the market with my money.

I understand your point, but the Government IS the market at the moment. If they leave the market, then say hello to a massive great depression.

I don't think the Government will leave the market anytime even in the next decade.

I think the market will be in a stasis, where losses are acknowledged slowly over time.

Full paper on Credit Deflation:
http://libertarianpapers.org/2010/43-boyapati-why-credit-deflation-is-more-likely-than-mass-inflation/

bmwman91 says

This cancerous notion of "credit = affordability" needs to be purged from our society. It probably won't happen, and I think that house prices will continue to slump towards greater affordability as long as loans are made properly difficult to obtain.

Credit especially for pure consumption should always be discouraged and should never be allowed to occur when household incomes can't support credit growth. Seems so obvious, but when the economic growth itself depends on credit growth - you can see why things went to the crapper.

I like the approach of factoring in savings deflation. In general, are people big savers these days? I've always thought the generation of savers disappeared before 1972. Could be wrong.

GoranK says

In general, are people big savers these days?

Short answer is No.

Here's the data: http://research.stlouisfed.org/fred2/series/PSAVERT

GoranK says

I've always thought the generation of savers disappeared before 1972. Could be wrong.

I would say it has been in decline (choppy nevertheless) since Reagan.