Affordability Improved Amid Soaring Nominal House Prices, According to First American Real House Price Index
First American Financial Corporation (NYSE: FAF), a leading global provider of title insurance, settlement services and risk solutions for real estate transactions, today released the January 2021 First American Real House Price Index (RHPI). The RHPI measures the price changes of single-family properties throughout the U.S. adjusted for the impact of income and interest rate changes on consumer house-buying power over time at national, state and metropolitan area levels. Because the RHPI adjusts for house-buying power, it also serves as a measure of housing affordability.
Chief Economist Analysis: Soaring Nominal House Prices Don’t Tell Affordability Story
“Soaring nominal house prices dominate recent headlines and for good reason. It is true that nominal house prices are the highest they have ever been, over 22 percent higher than the housing boom peak in 2006, according to the First American Data & Analytics House Price Index,” said Mark Fleming, chief economist at First American. “The acceleration in the pace of annual house price growth began in the summer months of 2020, as potential home buyers emerged from lockdowns armed with record low mortgage rates and were met by historically low housing supply – a perfect storm for rapid nominal house price appreciation.
“By conventional measures of affordability, especially in an environment of modestly rising (in some markets declining) household income, a surge in nominal house prices implies significantly reduced affordability,” said Fleming. “Yet, nominal house price fluctuations alone, or even the relationship between nominal house price growth and income growth, can be a misleading indicator of affordability, and overlooks what matters more to potential buyers – house-buying power -- how much home one can buy based on changes in income and interest rates.
“For example, let’s assume you earn $100,000 a year, have a 33 percent debt-to-income ratio, and put down 5 percent on a home. With a 4 percent mortgage rate, your house-buying power is $606,000. But, if rates fell to 3 percent, your house-buying power increases by $80,000. Our Real House Price Index (RHPI) adjusts nominal house prices for purchasing power by considering how income levels and interest rates influence the amount one can borrow,” said Fleming. “The ability of low or declining interest rates to boost house-buying power makes it possible for a housing market to have high or even rising nominal house prices yet remain highly affordable (as measured by the RHPI) and vice versa. Indeed, a walk down house price memory lane shows us that nominal house prices alone are not always a good measure of affordability.”