On Friday, U.S. mortgage rates hit 6.9%, the highest rate since April 2002.
American homes are now officially unaffordable.
At current prices, mortgage payments on the average house will now consume 42% of a median U.S. family’s income, according to data from Fannie Mae and analysis from InvestorPlace.com. That’s far higher than the typical “28% rule,” a guideline that limits mortgage payments to 28% of pretax income.
Much of the unaffordability stems from high home prices. Real residential property prices, as tracked by the Bank of International Settlements, have jumped 60% from 2000. The median American home now costs around $450,000, or 5.1 times the annual gross salary.
Rising mortgage rates, however, have an even larger effect. All else equal, first-time homebuyers can afford 40% less today than they could have 12 months ago.
The difference is even greater for those with poor credit. A homebuyer with a credit score of 620 will now need to spend $3,718 on monthly payments for a hypothetical $400,000 loan, up from $2,386 in 2021.
2023 is shaping up to be even worse. According to estimates from CoreLogic, a real estate data firm, home prices could rise another 3.8% year over year. With markets now expecting a Fed funds rate of 4.6% by early next year, the median house could cost an average new homebuyer almost half of their pretax income.
Should You Buy a House in 2023?
Current homeowners will see the price volatility as a non-event, especially those with portable mortgages at low rates.
But the picture for renters and first-time homebuyers is decidedly more mixed.
According to data from the Pew Research Center, 9.9 million renters in the U.S., or 23%, already spend more than 50% of their income on housing costs. 31% of women and 37% of men between ages 25 to 29 now live in multi-generational households, usually in the parents’ house. Rising mortgage rates and stubbornly high house prices threaten to keep these buyers from entering the market.
Investors are also struggling to find deals. Real estate cap rates, the profit margin of investing, now sit at their lowest point since records began.
That’s bad news for American homeowners too. For housing markets to reach historical norms, home prices will have to fall anywhere from 15%-25% from current levels.
Cracks in the real estate market are already emerging.
“Many prospective buyers have paused and moved to the sidelines amid higher mortgage rates, along with ongoing inflation and a range of macroeconomic and geopolitical concerns,” warned Chairman and CEO of K.B. Homes (NYSE:KBH) Jeffrey Mezger in his Q3 earnings call. “There’s no question the market is softer than it was last September.”
But to truly reach affordability, U.S. home prices will need more than softness; they will have to drop at a rate unseen since the 2008 financial crisis. And if that happens, it’s going to be a wild 2023 for all markets.
Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.