Written by First American Chief Economist, Mark Fleming
Affordability improved in October as two of the three key drivers of the Real House Price Index (RHPI), household income and mortgage rates, modestly swung in favor of increased affordability relative to one year ago. The 30-year, fixed-rate mortgage fell by 1.1 percentage points and household income increased 2.6 percent compared with October 2018. Rising household income and declining mortgage rates each boost consumer house-buying power.
“While rising house-buying power, largely driven by declining mortgage rates, made monthly mortgage payments more manageable in 2019, any further increases in house-buying power will likely rest on the labor market and continued household income growth in 2020.”
While home buyers benefitted from the increase in house-buying power driven by lower rates and household income growth, they also face greater competition for homes as increased house-buying power has also fueled greater demand. As demand increases for a scarce (limited or low supply) good, prices will rise faster. The housing market saw this dynamic play out in October as nominal house price appreciation accelerated relative to a year ago. However, even as nominal house prices have gained momentum because of the supply and demand imbalance, real house prices (RHPI) actually declined by 7.9 percent thanks to the benefit of increased buying power. The increase in house-buying power was more than sufficient to offset nominal house price gains. In order to understand these dynamics, let’s break down the three forces driving the RHPI, and what they signal for 2020.
Rising Income + Low Mortgage Rates = Faster House Price Appreciation
- Income on the Rise: The labor market impressed again in October as annual hourly wage growth increased by 3.2 percent compared with a year earlier, job growth remained steady, and the unemployment rate fell to 3.5 percent, a 50-year low. The rise in wage growth contributed to a 2.6 percent year-over-year increase in average household income. Compared with October 2018, the rise in household income increased consumer house-buying power by $9,300. The outlook for the labor market remains strong, especially given that job creation continues, and wages are still rising.
- Rate Drop: While mortgage rates increased modestly in October compared with one month ago, they are still significantly lower than they were a year ago. The decline in mortgage rates from 4.8 percent last October to 3.7 percent this October boosted house-buying power by an impressive $51,800. Combined with the gains from household income, overall house-buying power improved by more than $61,000 compared with October 2018. Looking ahead to 2020, mortgage rates are expected to remain relatively flat, but stay below 4 percent. If that is the case, then any further improvement in house-buying power will be driven by household income gains and the health of the labor market in 2020.
- Nominal House Prices Rise: Economics 101 teaches us that in a market with strong demand and limited supply, we can expect faster house price appreciation. Since the beginning of the spring home-buying season in April 2019, house price appreciation has accelerated. Yet, rising house-buying power has outpaced the rise in nominal house price appreciation, for now.
More Millennial Buyers on the Way in 2020
The bulk of the millennial generation, America’s largest generation, will turn 30 next year, entering their prime home-buying years. This generation of buyers grew up in an era of sub-4 percent mortgage rates and also have higher household incomes than their predecessors. Financial readiness combined with a heightened appetite for homeownership will power continued demand for homes in 2020. Yet, there is not enough supply to meet the growing demand, so we expect faster house price appreciation, a dynamic we’re already experiencing in the housing market today. While rising house-buying power, largely driven by declining mortgage rates, made monthly mortgage payments more manageable in 2019, any further increases in house-buying power will likely rest on the labor market and continued household income growth in 2020.
For more analysis of affordability, please visit the Real House Price Index.
The RHPI is updated monthly with new data. Look for the next edition of the RHPI the week of January 27, 2020.