Demand is Dropping Due to Affordability
When escalating home prices are matched with much higher mortgage rates, home affordability dramatically weakens and results in fewer buyers able to make a purchase.
According to the most recent Steven Thomas Orange County Housing Report (05.31.22), lower rates had propped up affordability, yet today’s higher interest rate environment is impacting demand as many home buyers struggle to afford the monthly payment.
In May of 2021, a gallon of gas cost $4.07. In January of this year, it had increased to $4.59, a rise of 52 cents in 8 months. It climbed to $5.66 a gallon in April, and then to $6.17 in May. That is a $1.58 jump in 4 months. Everyone is acutely aware of soaring prices at the pump. As consumers feel the strain in their monthly budgets, the rising fuel cost will begin to impact discretionary spending.
Mortgage rates have experienced a similar fate, climbing from 2.78% last August to 3.25% by the start of this year. They then jumped to 4.95% in April and sit at 5.25% today. This two-point rise since ringing in the New Year sidelined many potential buyers as home affordability has impacted the ability for many to qualify and purchase a home.
In looking at home affordability it is critical to look at home prices, household incomes, and the prevailing mortgage rate. Home values have risen sharply since the start of the pandemic. In fact, the national Case-Shiller Home Price Index increased by 20.6% year-over-year in March, a record rise. Higher prices were not a problem when rates were in the two’s and three’s and buyer demand was through the roof; however, today’s 5.25% mortgage rate, according to Mortgage News Daily, is a significant jump that has squeezed buyers swiftly. As a result, the demand for Orange County Housing has weakened.
Orange County Housing Report 05.31.22
To understand where this weaker demand is coming from it is necessary to consider where interest rates and incomes have been historically and their impact on affordability. The chart below highlights how interest rates have been a lot higher and limit the price of a home that a buyer can afford. In 1980, the average mortgage rate was 13.75%, the median income was $22,000, and the median detached sales price was $108,000. That meant that the monthly housing payment was 55% of a homeowner’s income. Rates continued to drop, and incomes climbed decade after decade. In 2000, mortgage rates were at 8%, the median income grew to $56,000, and the median detached sales price had blossomed to $317,000. Yet, the monthly payment was only 40% of a homeowner’s income. It swelled to 59% in 2007, just prior to the start of the Great Recession, and dropped to 33% in 2012 as housing began to climb once again. In 2020 and 2021, even as the median price of a home had rocketed to record levels, the monthly payment was at 37% and 44% due to historically low mortgage rates. Affordability was not an issue as mortgage rates had dropped to record lows. Flash forward to today’s 5.25% mortgage rate, $106,000 median household income, and a record setting April median detached sales price of $1,325,000, the monthly housing payment is 66% of a homeowner’s monthly paycheck. That is way too high for the average home buyer.
Skyrocketing home values were not a problem in 2020 and 2021 when rates reached 17-record lows. But, as rates have climbed from 3.25% to 5.25% in just a few months, home affordability has rapidly eroded like a sandcastle at high tide. Many potential home buyers no longer qualify to purchase a home, or their purchasing power has greatly diminished. A payment on a $1 million home with 10% down at the start of the year was $3,917 at 3.25%. Today, it is $4,970 at 5.25%, a $1,053 per month rise in the first five months of the year. Additionally, a buyer looking to spend $4,000 per month was touring homes at a $1,021,111 at the start of January. Today, that same buyer is now considering homes at $782,222. Their purchasing power plunged by nearly $240,000.
Orange County Housing Report 05.31.22
Even with home values reaching record highs, the housing market is rapidly cooling. There are fewer showings, fewer multiple offers, and homes are taking longer to sell. Overpriced homes are sitting, the inventory is rapidly growing, and price reductions are on the rise. In Orange County 22% of all available homes to purchase have reduced their asking price at least once. Demand, the number of pending sales over the prior month, is down by 31% compared to one year ago. It is down 22% compared to the 3-year average prior to COVID (2017 to 2019). In fact, demand is at its lowest point for this time of year since 2007, intentionally omitting the pandemic lockdowns of 2020.
The Bottom Line: The quick rise in mortgage rates has substantially eroded home affordability and the Orange County housing market is rapidly cooling. It all boils down to the monthly payment. When the monthly payment climbs out of reach for many home buyers, demand cools. The housing frenzy is quickly coming to an end. Sellers need to be careful in navigating the new housing landscape. Carefully pricing is fundamental in order to find success.
If you’re interested in buying or selling your home, or have questions about the market, reach out to one of our agents today:
