About the author: Laurie Goodman is vice president for housing finance policy and the founder of the Urban Institute’s Housing Finance Policy Center.
Home prices have risen 81.5% in the United States over the past decade, including: 17.6% only in the last year. This sharp rise in house prices is partly due to the acute housing shortage that emerged in the wake of the Great Recession, when new housing construction slowed to below the level needed to provide for new households. This deficit has only worsened in the past year as interest rates have fallen in response to the Covid-19 pandemic, leading to increased demand from would-be homebuyers who can suddenly afford to pay more for a home.
In this market, who wins and who loses? And does it promote or hinder economic and racial equality?
Simple: the winners are homeowners. They are allowed to keep any accumulated increase in the house price. This both increases their net worth and provides them with an additional source of equity against which they can borrow if necessary. They may also be able to take advantage of today’s low rates to refinance their mortgage, reducing their monthly payment.
Unlike homeowners, tenants lose in this market. At least those who want to become homeowners do. For starters, the rise in home prices means it costs more to buy a home. And yes, the current low interest rates are helping to offset those higher costs, but house prices have risen more than interest rates have fallen. As a result, today’s home buyers are facing a higher monthly payment for the same home than in early 2020, before the start of the Covid-19 pandemic.
Another challenge presented by this market is: qualifying for a mortgage. Two of the criteria that mortgage lenders use to qualify borrowers are the loan-to-value ratio, which is the size of the mortgage loan compared to the value of the home, and the debt-to-income ratio, the value of the borrowers’ total monthly debt payments as a percentage of their total monthly income. In today’s market, borrowers may find it more difficult to meet the requirements of lenders regarding these ratios.
As home prices rise, home buyers’ down payments also increase. The larger the down payment, the smaller the mortgage loan and thus the lower the loan-to-value ratio, making it easier to qualify for the mortgage. In today’s economy, saving for a down payment can be particularly difficult because inflation outpaces wage growth. People are forced to spend more on everyday needs, especially their rent payments, which are rising rapidly in some markets and have less money left to save for a down payment on a house.
In addition, because we know that monthly mortgage payments have increased in the current market, borrowers will have a higher debt-to-income ratio. That is, unless the borrower’s income has also risen at least as much as house prices. Unfortunately, this is not the case for most tenants. Although house prices rose by 17.5% last year, the average hourly wage grew only by only 3.5%. Consequently, most borrowers are likely to have a higher debt-to-income ratio, making it more difficult to qualify for a mortgage.
Taken together, these factors make it much less likely for current renters to acquire a home. And that is a big problem, partly because the financial benefits of home ownership are considerable. Assuming the homeowner has a fixed-rate mortgage, she has guaranteed herself the same monthly payment for the duration of the loan. Yes, property taxes, insurance and home maintenance costs can fluctuate, but they are the minority of the monthly payment. The bulk of the payment — principal and interest — remains fixed, resulting in a housing payment that is not only predictable, but immune to inflation. That is a particularly useful advantage in today’s market, when inflation is rising.
Unfortunately, tenants lack this predictability and stability. Instead, a renter can expect her rent to rise each year, likely faster than headline inflation given the current tight housing supply. Moreover, the tenant is at the mercy of the landlord. If the landlord decides not to renew the lease, the tenant will be forced to relocate, which may require children to change schools and employees to find another job or accept a longer commute.
Owning a house is the best way to build wealth. Housing is a leveraged investment, with the average new buyer putting down about 5% of the home’s value and borrowing the rest. A modest 3% increase in the value of the home is the equivalent of a return of almost 60% per year on the initial investment. So it’s not surprising that the average homeowner is about 40 times more wealth than the average renter, about $255,000 versus $6,300, about half of which is housing.
But it’s important to note that the demographics of homeowners differ significantly from those of renters, disparities that fuel the self-perpetuating cycle of economic and racial inequality in our country. Homeowners in particular earn more money. According to the 2019 American Community SurveyThe median income for homeowners is $82,000, compared to a median income of $42,500 for renters. And homeowners are more likely to be white. About 28% of non-Hispanic white households are renters, compared to 58% of black households and 52% of Hispanic households.
This means that the people who benefit most from the current housing market, the whites, are wealthier or both. On the other hand, people of color, those with lower incomes, or individuals who fall into both groups are more likely to struggle. The consequences of such differences are both obvious and worrying. They include further entrenching the economic divide that already exists between people with more money and those with less, and between people of color and whites. Today’s higher house prices will only make it much more difficult for people of color and low and middle incomes to catch up by hindering their access to affordable home ownership.
The current housing market limits mobility, especially for people moving from cheaper to more expensive areas. Despite all the talk of people no longer moving to cities with high housing costs, the fact is that house prices are also rising rapidly in previously affordable cities with good jobs, such as Austin and Denver. If people can’t afford to live in these cities, they can’t move there either. And that’s an economic loss, both for the workers who can’t move and for the wider economy that needs those workers.
We can address some of these challenges by creating additional homes. This will slow the pace of home price growth and allow more tenants to become homeowners, which in turn will help both alleviate the housing shortage that currently plagues virtually every community in America, and level the economic playing field for the millions of tenants. low-income and renters of color who are unable to make the crucial transition to home ownership in today’s market.
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