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Published: Feb 15, 2022 6 min read
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The race toward homeownership is getting more challenging. For many Americans, low inventory, high prices and — most recently — rising mortgage rates are putting a home purchase out of financial reach.

Price growth has been an issue over the last two years. Sale prices have increased by almost 30% since December 2019 thanks to a surge in buyer demand, according to the National Association of Realtors. As a result, it costs about $80,000 more to buy a typical home now than prior to the pandemic.

For a while, low interest rates meant home buying penciled out for many households despite rising prices. Now, with mortgage rates up dramatically since January, affordability is taking another hit.

“Rising rates will hamper affordability even further,” explains Nadia Evangelou, senior economist and director of forecasting for NAR. “Higher rates increase mortgage payments and typically reduce the amount of money people can borrow.”

Evangelou estimates that as many as 4 million households could see their borrowing power weakened by continuously rising rates this year.

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The impact of rising rates

While the lack of inventory and high home prices have been issues since the early days of the pandemic, historically low interest rates helped counteract their effect on affordability to some extent. For a time, buyers even found themselves able to afford more expensive homes while keeping their monthly payments manageable.

That’s no longer the case. According to mortgage data provider Black Knight, the monthly principal and interest payment needed to purchase an average-priced home is at an all-time high of $1,454 — up $350 per month year-over-year.

That means, it currently takes 25.8% of the median monthly household income to pay for the average home, with a 30-year loan and a 20% down payment. It’s the worst affordability level since 2008. By comparison, prior to the Great Recession, the average pay-to-income ratio was 25%.

With interest rates expected to increase further by the end of the year, buying is going to get even harder.

A buyer with a monthly housing budget of $2,000 would lose an estimated $13,750 in buying power if interest rates rose from 3.5% (roughly where rates were a week ago) to 3.9%, according to real estate brokerage Redfin. This means that instead of being able to buy a $396,000 home, that buyer would be able to afford a $382,250 home.

In fact, average rates rose so much last week — from 3.55% to 3.69% — that a buyer with a $2,000 monthly budget lost $5,250 in buying power.

“If rates were to rise much further in a typical market, we would expect there to be a turning point: Buyers would go from feeling more urgency to buy to feeling less urgency. That’s because rates would ultimately reach a point where renting is more feasible than buying,” said Daryl Fairweather, Redfin’s chief economist. “But this isn’t a typical market.”

Fairweather pointed out that rental prices are surging as well, and many homebuyers may decide to turn toward smaller homes and more affordable areas to make up for the loss in affordability. On the other hand, it may be best for some buyers to put their plans on hold.

“Affordability is really the key factor here” comments Rob Heck, vice president of mortgage at online mortgage marketplace Morty. “If the recent rate changes mean that someone can no longer afford to buy a home, that’s a sign that their budget may already have been stretched and that they need more time to improve their financial profile.”

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Lower-income households are hurt most

Potential buyers with household earnings below $100,000 are seeing the biggest loss of affordability.

For every 125 households earning between $50,000 and $75,000, there is just one affordable home for sale, according to NAR. This is down from one listing for every 46 households in 2019. (A listing is considered affordable if a household could spend no more than 30% of their income on housing expenses.)

On the other hand, buyers with incomes between $100,000 and $124,999 have nearly 3.5-times as many options, with one affordable home for sale for every 36 households in this income bracket. And the numbers improve further as you move up the income ladder.

A small bright spot? While affordability for lower-income households is eroding in many markets, there are some places where listings are more plentiful. According to NAR, the three most affordable markets for households in the $50,000 to $75,000 income range are Des Moines, Iowa (one listing for every 78 households)l Detroit, Michigan, (one listing for every 79 households); and Augusta, Georgia (one listing for every 80 households).

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