1997: the last market bottom
- The market peaked in the spring of 1990 at $245,000. In early 1997, the median was $223,750. It dropped for 7 consecutive years (The data series is a bit noisy, but the lowest low was recorded at $192,750 in May of 1994).
- There where bear rallies almost every year similar to what we are seeing now.
- The median household income was $62,022.
- The median home price was $223,750.
- Mortgage interest rates were at 7.6%. Rates had been steadily falling since 1982.
If a borrower puts 20% down on a $223,750 home, they are putting $44,750 down and borrowing $179,000. The payment on $179,000 at 7.6% interest is $1,263.87. This amount represents 24.4% of the median household’s $62,022 income.
Think about that: in 1997, a family making the median household income could buy a median home with a payment that was less than 25% of their income.
One of the erroneous contentions real estate bulls have made over and over again is that the median household income could never buy a median home. That is simply nonsense.
Twenty percent down was the norm in 1997, but what about the first-time buyers who were only putting 3% down with an FHA loan? They would have put down $6,712, borrowed $217,037, and they would have had a payment of $1,532. This payment would have been 29.6% of their income. By any standard, houses were affordable in 1997.
So what would these same market conditions which prevailed in 1997 look like today?
- The median household income in 2008 was $91,101. I doubt it went up since then.
- The current mortgage interest rate is about 5.25% (It fluctuates wildly lately).
If a family making the median household income were to put 24.4% of a $91,101 income toward a payment, they could make a payment of $1,852.39. That payment would finance $335,452. A 20% downpayment of $83,864 combined with the $335,452 loan would yeild a median home price of $419,316.
If the people in 2009 were putting the same percentage of their income toward housing as those who bought in 1997, the median home price in Irvine would be $419,316.
House prices did not go up by magic. People were utilizing crazy loan products that allowed them to borrow unbelievable sums, and they stretched beyond the limit to borrow these massive sums. The collapse of these loan products has already resulted in a huge decline in borrowing. People are still stretching to an insane degree and putting very large downpayments to keep our median at $550,000. As those with large downpayments spend themselves, and as people stop stretching to buy depreciating assets, the median will continue to fall.
Keep in mind that the $420,000 median we should be seeing is only supported by artificially low interest rates. If interest rates go back up to their historically stable levels of near 8%, the amounts financed drop even further.
What would happen if incomes were to remain flat and interest rates were to rise to 8% by the summer of 2011? (This probably will not happen, but it could.) Using all the same parameters and an 8% interest rate yields a median home price of $315,561.
- If you knew the median household income went up about 50% from 1997 to 2008 ($62,000 to $91,000), wouldn’t you suspect house prices would also have gone up 50% ($223,750 to $335,625)?
- Is it logical to think house prices can go up more than incomes?
- How are people capable of bidding up house prices higher than their incomes would allow?
- If lending standards retreat to 1997 standards (which they have), shouldn’t the relationship between income and price also mirror 1997 characteristics?
When I was interviewed recently at the Irvine Homes Blog (Blogger: Irvine housing market nowhere near bottom), I said that I believed the Irvine median would bottom near $375,000, particularly if interest rates rose to 7%-8%. When you look at the math, and look at the history, the crazy number that I threw out looks reasonable and even conservative.