Are you ready to make the big financial leap and purchase your first home? Going from your parent’s home or even a rental property to your own house is a significant financial decision.
There are many questions to be asked, especially when it comes to your finances.
A new research report shows that while U.S. home prices are skyrocketing, income has remained mostly flat, making homeownership for Gen X, millennials, and younger generations more of a dream than a reality.
Since 1965, home prices have increased 7.6 times faster than income, and 3.1 times faster since 2008. Average home values grew from $171,942 to $374,900, an increase of 118%, while median household income grew from $59,920 to $69,178, an increase of just 15%, adjusted for inflation.
Financial experts recommend home buyers use a house-price-to-income (PTI) ratio of 2.6 when estimating how much mortgage they can afford. But from 2019 to 2021 alone, the median PTI ratio increased by 14.9% — from an already elevated 4.7 to 5.4 — meaning homes in 2021 cost 5.4 times what the average person earns in one year.
The PTI ratio crisis in the U.S. may impact both current and aspiring homeowners. Homeowners who paid top-dollar prices when they bought during the pandemic may currently be enjoying high home values, but they could be in trouble if those values plummet in the next housing crash.
Likewise, more home buyers are getting priced out of the market as mortgage rates climb (up from 3.14% to 3.18%), supply remains low, and prices remain high.
Read on for more insights into how these shifts are affecting the U.S. market and how home buyers can determine if they’re ready to get a foot in the door of homeownership.
How Much Income Do Americans Need to Buy a Home?
The median household income is currently $69,178. To afford a home in 2021, a U.S. home buyer needs an average income of $144,192 to afford the current median home price of $374,900.
The current PTI ratio of 5.4 translates to the number of years the average home buyer needs to save in order to purchase a home.
But more than a down payment and closing costs, sky-high home prices also translate to monthly mortgage payments that may be out of reach for some buyers who may already be at the limits of their home-buying budget.
Don’t forget to factor in the monies needed for escrows on taxes, insurance, and mortgage insurance.
Homes that need renovations and other improvements require even more financial considerations.
Housing affordability is a combination of home prices and income, and while the price-to-income problem is widespread with historic highs, it is low-income service workers who are most affected.
Though wages may be higher in larger metro areas, the lack of new affordable housing and exorbitant prices on existing housing stock undermine any wage advantage.
The Most and Least Affordable Places to Live in the U.S.
The same research study found that nearly 90% of major U.S. metros have a PTI that exceeds the 2.6 ratio considered healthy by economic experts.
Only six out of the 50 largest major metro areas have a PTI ratio in the recommended range of 2.6 or lower:
- Pittsburgh (2.2)
- Cleveland (2.4)
- Oklahoma City (2.5)
- St. Louis (2.5)
- Birmingham, AL (2.5)
- Cincinnati (2.6)
California is home to the least affordable housing in the U.S. with exceptionally high PTI ratios:
- Los Angeles (9.8)
- San Jose (9.1)
- San Francisco (8.3)
- San Diego (7.8)
The gap between soaring home price growth compared to relatively flat income growth touches other corners of the U.S. besides California. New York’s home-price-to-income ratio clocks in at 6.6, Miami at 5.6, Seattle at 5.5, and Salt Lake City at 5.2.
And as home prices outpace income rates nearly everywhere in the U.S. in the 50 most populated cities home values between 2017 and 2021 on average increased 17.8%, while income increased only 6.2% — meaning home prices grew 2.8 times faster than income.
Average home values in America’s 50 most populated cities grew from $271,70 in 2000 to $304,589 by the 2008 housing crisis, to $376,826 by 2021, reflecting the effects of the COVID-19 pandemic on the U.S. housing market.
Not surprisingly, in America’s most expensive cities, housing got more expensive: The average PTI ratio increased 61% since 2000, creeping up to 6.9%. In comparison, cities with the lowest PTI ratio grew just 10% since 2000, averaging 2.3.
More Equity Now Could Sink Homeowners Later
Climbing home prices increased homeowners’ equity from 2015 to 2020, likely a factor for the 54% decrease in underwater mortgages in the largest metro areas, a change of 12.2% to 5.6%.
The cities with the biggest decrease in underwater mortgages include:
- Salt Lake City (1081% decrease from 18.5% to 1.6%)
- Las Vegas (513% decrease from 21% to 3.4%)
- Phoenix (471% decrease from 16% to 2.8%)
- Seattle (467% decrease from 10.3% to 1.2%)
- Tampa, Fla. (315% decrease from 16% to 3.9%)
While homeowners are seeing increased equity now because ofo high home prices, it’s possible they could find themselves underwater in the next housing crash.
The housing crisis that was predicted in the first months of the COVID-19 pandemic never happened. Thanks to government aid, low-interest rates, and homebuyers seeking a geographic adjustment to pandemic problems, the housing market took off, sending prices skyrocketing as stock became limited.
In particular, homeowners who bought at the peak could find themselves underwater on their mortgages when the period of high demand and low supply tapers off as it historically does, and the housing bubble pops. And while it might be great for sellers, high home prices create a strain on the market if the pool of home buyers shrinks due to an inability to find an affordable property.
Can You Afford to Buy Right Now?
Home buyers determined to purchase now should proceed with caution and consider the market and their personal situation carefully. Work with a qualified real estate agent who can help you navigate an uncertain climate.
Some questions to consider before you buy:
- Do you have 20% for a downpayment? Not only does a traditional 20% down payment lower your mortgage payment, but it also saves you the cost of private mortgage insurance, which can be anywhere between 0.3% and 1.2% of the balance of your loan.
- How long do you plan to stay in the home? When the market pops, how likely is it you’ll be underwater on your mortgage? If you’re planning to stay in the home for the long haul, you’ll have time to build back any equity lost in a housing crash.
- What’s the post-purchase cost to live in this home? If you’re buying at the peak of the market, can you afford the monthly mortgage, plus taxes, insurance, and maintenance?
Final Thoughts
Buying a home for the first time is a big deal both financially and mentally. A home purchase should never be ready until you are truly ready. Make sure your financial house is in order before making such a life-changing decision.
You should make absolutely certain you have the income needed to buy a home in 2021 and into 2022.