Bad news: The American dream may be unreachable.
That was the overarching message from S&P Global’s Chief North American economist Beth Ann Bovino who, in a somewhat disheartening report released on Wednesday, flatly declared homes “too expensive” for first-time homebuyers.
Her assessment was based on a straightforward analysis of the length of time required to save for a down payment and the rising cost of servicing a mortgage.
I’ve suggested the down payment discussion often gets short shrift when it comes to assessing housing affordability. S&P echoed that. “Although mortgage payments usually top expenditures for a homebuyer, the decision to purchase a home may affect a family’s quality of life well before they enter the housing market,” the report said.
On the eve of the subprime collapse, a typical first-time homebuyer with the median income needed to save for 35 years to afford a 20% down payment, assuming the national average savings rate. That fell to a post-financial crisis low of “just” nine years in Q4 of 2012, but following a brief dip associated with pandemic distortions, the figure is projected to rise back to almost 23 years in short order (figure below).
According to S&P’s projections, it’ll take the average first-time buyer more than 11 years to save even a 10% downpayment by the end of 2022.
The idea that average households need to save for a quarter century to become actual “households” (i.e., to have a house) is ludicrous. Consider all that can happen in 25 years, from emergencies to children to illnesses to job losses to inflation. Sticking with a savings plan for that long on the median income is very difficult, and it’s also worth noting that even if you start very early, homeownership won’t be a reality until you’re middle age, assuming no material change in financial circumstances.
As for the 10% down payment option, it’s not ideal for a laundry list of reasons, ranging from the trivial to the not-so-trivial. There’s PMI (initially, anyway), higher monthly payments, higher odds of being underwater in an (admittedly unlikely) crash and so on.
But what’s particularly troubling about the figure (above) is the trend over time. In the early 70s, an average American earner could save enough for a 20% down payment in under five years. In that context, it’s remarkable that society tolerates the scenario that’s persisted to varying degrees over the past two decades. In 2005, it would’ve taken the average American 35 years to amass a 20% down payment. That may as well be never. Virtually no one will start saving for a down payment at 30 and happily purchase their first home at 65. That hypothetical buyer is literally hypothetical — she doesn’t exist. At some point between 30 and 65, circumstances will change such that homeownership is brought forward (e.g., a promotion or starting a two-earner family) or ruled out altogether.
S&P’s Ann Bovino summarized the macro environment and the likely impact on Americans’ down payment burdens. “According to our estimates, the number of years to save is set to rise above pre-pandemic levels in the four years from 2021 to 2025, due to tighter monetary policy, a faster increase in home prices relative to household income from Q1 2022 to Q2 2023, and a lower-than-pre-pandemic saving rate persisting until the end of 2023 as higher inflation forces households to dip into savings to make ends meet,” she wrote.
Meanwhile, S&P now projects that for first-time buyers who only manage a 10% down payment, mortgage payments as a share of income probably exceeded 25% last quarter, and may rise to 28% by the end of the year, the highest since Q1 of 2007. That, the report noted, is a direct consequence of “soaring home prices and mortgage rates.” On the NAR’s guidance, anything over 25% isn’t affordable.
It’s likely, S&P said, that the middle-fifth income bracket (and the brackets lower than that) was priced out of the market. Here are the two key excerpts from the report (abridged):
Lower-income households in the bottom 40% [are] already pushed out of the market. By Q1 2022, a middle-income first-time homebuyer was not able to afford monthly mortgage payments, with 60% of households no longer able to afford a home through Q4 2025.
Worsening home affordability has likely pushed the average household… out of the affordable range. For those in that bracket and lower, about 60% of potential homebuyers, the ability to buy a home is no longer an affordable option.
Again, it’s remarkable that citizens in an advanced economy (let alone taxpayers residing in the richest nation the planet has ever known), tolerate such a conjuncture.
The excerpted passages from S&P allude to lower-income cohorts being completely priced out. For the bottom quintile, this entire discussion is completely irrelevant — totally meaningless. On S&P’s projections, the lowest quintile of earners will soon need to come up with 150% of their pretax income to afford the mortgage on a starter home. That number hasn’t been materially lower than 100% since the early 70s. In other words, homeownership has never been possible, even in theory, for the least fortunate Americans.
As far as down payments go, S&P’s projections suggest that by the end of 2022, households in the lowest quintile would need to save for 105 years in order to make a 20% down payment on a starter home. Call me a pessimist, but that seems far-fetched.
“Again, it’s remarkable that citizens in an advanced economy (let alone taxpayers residing in the richest nation the planet has ever known), tolerate such a conjuncture.”
It’s not all that surprising when you have a home ownership rate of ~65%. For that 65% (who are more likely to vote), they just see dollar signs from their “investment”. Everyone else is too busy trying not to drown to vote, especially when it comes to local elections where most housing policy is decided. For those younger folks who don’t own a home, they just have to hope they inherit their piece of the American dream (and the continued property tax breaks if they are lucky enough to inherit in California).
FHA/VA and state housing agencies have very low downpayment options of around 5% or less designed for first time buyers-and there is also PMI. Not trying to trivialize the problem, but the downpayment problem may not be quite as big as you are posting. The real problem is affording the payments and the risk, furnishing a house and having an emergency fund in case. If you have a family there are tons of expenses, not just housing. In order to have a shot of making it past the first 4-10 years (where the risk of default is highest) of being able to afford a house, most middle class families need two incomes and need to be very disciplined about budgeting. This post suggests that maybe mortgage rates need to come down and prices need to be flattish for awhile – just like 2008-2018. At that point incomes will have a chance to catch up to house payment levels. This has happened before and that is what is likely to happen again. The Fed is trying to engineer this type of softish landing.
And what about the long-term ramifications of a 5% down payment? To call that suboptimal would be to materially understate the case. The bottom line is that the math doesn’t work for the vast majority of buyers. I’ve avoided pointing this out on the advice of some of my richer neighbors here on the island (who are perpetually concerned about the very same kind of civil unrest flagged by fund managers in this month’s BofA survey), but the math doesn’t really work out all that well even for America’s upper-middle class. That’s another one of the little “secrets” that gets swept under the rug. When you buy a $900,000 home in cash and sell it up 30%, that’s profit (minus fees and closing costs). When you put 20% down and pay interest over three decades on the other 80%, the math’s a little different. This is just another farce foisted on everyone who isn’t 99%ile and up.
No doubt my colleague RIA has seen many of his clients lucky enough to be in the top 5% sending money to cover a child’s down payment or more on a home. Of course, if you do it for one kid, you’d be wise to offer it to all of them.
Thus the seemingly insatiable bid in some markets. It also accounts for some of the “sold for cash” stats that many assume are by Blackrock & such.
That helps explain some of the resilience, but it may just make it worse for other not-so-lucky unsubsidized buyers. Netting things out a bit.
Beyond those lucky souls, Dr. H’s points still hold.
Thankfully for investors, when times get tough, Americans flock to the right
In Canada you only need to have a down payment of 5% (up to $500K purchase), but if your down payment is less than 20% of your purchase price the mortgage must be insured (there is a government and private corp. that you an get the insurance from). The cost of insurance can be as high as 4% (if you only put down the 5%) and that amount can be added to your mortgage. In addition, the 5% down payment can come from your RRSP (retirement account – you have to pay it back over 15 years). You still have debt service ratios that you have to meet but those are fairly lenient. Talk about not having any skin in the game 🙂
I’ve heard that the Canadian government has a “housing for all” policy, not only for the homeless but also literally paying for new construction (builders only receive a fixed amount of profit per unit) – your description of constructive financing fits. This obviously ruins the “invisible hand of the market” of profit.
Crazy idea: for the social good, moderate the idea of shelter as a capitalist business opportunity. Almost as if a society were to consider every citizen’s health as sacrosanct and not a vehicle for profit?
+1
I don’t think diligently saving one’s pennies to accumulate a 20% down payment has been the norm for a long time.
First time homebuyers use low-down payment financing, get help from family, in addition to saving, and the average down payment for a starter house is 7%. https://www.cnbc.com/select/average-down-payment-on-a-home-today/
Its not like a 20% down payment was affordable a few years ago and suddenly is not. If starter house price has gone from $200K to $300K, then the hypothetical 20% down payment has gone from $40K to $60K, either amount represents an extreme amount of saving for lower-income households.
A < 20% down payment is not good in some ways, but is good in other ways. Houses are the only asset that the average American can buy with 9:1 leverage, subsidized by the US govt, non-recourse.
In most cases, it is a very good investment, and in those cases the smaller down payment is better. In a few cases, it is a bad investment, and in many of those cases, a larger down payment just means a bigger loss for the borrower. Look back to past housing busts, how often would the difference between 20% and 10% equity have kept the homeowner above water?
Above is from the homebuyer POV. For the lender, the larger down payment is clearly better, but that’s not the issue here.
Interestingly enough, what I discovered when I sought a mortgage on my second house is that lenders actually prefer low down payments on a mortgage that can be readily sold. When I built a new house, I had to to go to six lenders to find one to give me a mortgage with 30% down. They would have to keep such a debt on their books and they wanted to sell all their mortgages as soon as they were closed.
Folks, I’m sorry, but some of your arguments as expounded in the comments here fly in the face of common sense. For example, there isn’t anything “good” about a tiny down payment cobbled together from unconventional sources, especially not if that means borrowing money from family so that you can turn around and borrow even more money to buy a highly levered asset. The fact that it’s a high quality asset helps, but it doesn’t change the fact that it’s silly in any context outside of the housing market. I mean, I just… this is another one of those discussions where my refusal to acquiesce to something that only makes sense because we all collectively decided that it’s the only (or most expedient) way to accomplish some otherwise desirable goal makes me seem like an outlier, when in fact I’m the one stating the obvious. If homeownership is something that we want to be universal, then we need to figure out a way to pay people enough money for their labor and/or reduce the price of homes, such that they (people) can buy them (homes) on financial terms that make common sense. Not “sense” with a bunch of self-referential caveats.
I’m not trying to be too obtuse. Let me state clearly my main problem with this system: It strips people of their agency. What it says to people is this: You know you can’t afford this, and we know you can’t afford this, but we’ve figured out a way to let you buy it anyway. I think that robs people of something important — namely, the sense of pride and accomplishment that goes along with buying a home on terms that make intuitive sense to all parties. When you put, say, a 30% down payment on a home and opt for 15-year terms (instead of 30), the whole thing starts to feel a lot more like something you accomplished, as opposed to something other people facilitated. The solution isn’t to shut people out. Rather, the solution is to figure out a way to make it possible for more people to clear the bar.
I think there is a problem here- mortgages are available with less than 20% down- that is a fact. You may not like the ramifications but you can buy a 400k house with a downpayment of 20,000 or less. Also, 100% of the population should not in fact buy a house or housing. The goal should be to perhaps get to 65- less than 70% – that is probably the practical limit. Some folks don’t want to own. Some are going to move in less than 5 years. Some may have to be overlevered to do it and would prefer to spend their cash flow elsewhere. Some may be early in their careers and cannot reasonably handle a mortgage financially. This country got in trouble in the early 2000s with this concept- from both Republicans (Bush- the ownership society) and some Democrats too. The ownership rate got pushed to around 70% and it got there with junk financing. A better goal would be to make decent affordable rental housing available to those that did not want or could not own and to level out the tax discrepancy. Raising the standard deduction indirectly helped in this. Housing gets to be an emotional subject for many but it is just like many other basic consumption goods. The country would be far better off figuring out how to help folks on the lower income and wealth rungs climb the ladder and to at least provide decent rental housing, universal health care coverage, universal retirement backstop (social security does this part way), more generous aid to the unemployed, help for disadvantaged folks to relocate to areas with better opportunity, infrastructure improvements, child care aid, public health improvements, plus regional and local development aid for areas left behind. Compared to these things home ownership is not the big issue for the USA.
Add generous aid to education or employment training to my list too…
The fact that only 40% can buy now is likely not a long run item. Mortgage rates doubled- my bet is they are going to decline soon. And most likely prices will flatten out or decline in most areas- you can see the Fed has induced a slowdown in housing now. A good bet is that incomes will outpace prices in housing going forward. That is what happened from roughly 2008-2019 and I would expect that again. The market is sending a signal to buyers that if they want they can be choosy and wait if they want.
I agree with Mr H’s sentiment, my paraphrasing: “creative financing and cobbled together and getting lucky are not a real solution”, hopefully from a different angle.
I hated when people said solar energy wasn’t economically feasible… literally they were arguing against physics and plant biology. This “fact” was created by distorted financial incentives. (i.e. Fossil fuel companies preventing innovation, investment, and implementation).
Housing = shelter should not be a privilege, it should be a right. Creating an industry of “financialization” (e.g. subprime and CDOs) is not an answer to a physical problem.
If we quibble about 70% should own their home vs 80% we’re arguing past a critical piece: nobody takes their home with them when they’re dead. “Ownership” is a human construct, whereas Shelter (during a lifetime) is a living-organism reality.
So how do we provide more Shelter and set cultural expectations that “less is fine”? Luckily in the US we have the available land and means to actually build and renovate wonderfully efficient and well sized homes – but we lack the societal cohesion due to a rigged game.
Cynically I see the trend to be (a powerful wealthy minority) turning an independent population into (rental) serfs: forever sweating and perpetually in fear of being kicked out.
I spent some time this evening building a model to compare IRR of home purchases with different assumptions of down payment, mortgage rate, PMI, appreciation, tax benefit, opportunity cost, holding period, etc.
My conclusion is that sometimes the cash buyer gets a better IRR, other times the highly levered borrower gets a (much) better IRR. Basically the lower the annual price appreciation relative to mortgage rate, the better off the cash buyer is; in a high appreciation market (like we were in for the last several years), the low-down-high-leverage buyer is better off, and potentially by a lot. At 30% appreciation over 30 years, they all get negative IRRs.
That is from a narrow IRR angle – when you include stability, freedom from rapacious rent hikes, redevelopment potential, the homebuyer looks even better off, whether he or she bought with cash or 5% down + PMI.
I think it is very important for people to own their own homes, when possible. Houses are the biggest asset class in the country, and the only one that is still mostly owned by ordinary people rather than the 1% or 0.1%, and that is the great majority of many people’s life savings.
If house prices were lower, that would help more people get on the train, but whacking prices down to there would subject a lot of people who previously got on the train to sudden defenestration.
I don’t see a good solution other than to help first time buyers get onboard with less than 20% down, if they need that help.
The sorry state in your article arises in large parts from exceptionally low rates – and now the stock market just can’t wait to get back there again. It’s all a very human situation, akin to someone unable to leave an abusive spouse: Afraid of change and the unknown; rather go back to what we know, even though it’s dangerous.
Interestingly, home ownership rates are similar in the US to those in a few (but not all) western European countries that we might consider to be more egalitarian. However, rates are much lower than in many other countries–e.g. Cuba (at least according to Wikipedia): https://en.wikipedia.org/wiki/List_of_countries_by_home_ownership_rate
As I’ve suggested before, the answers to housing issues (not just home ownership affordability) are shockingly easy to propose: more progressive tax policies; revise local zoning laws; institute policies for secure healthcare and housing for the elderly, including options for multi-generational housing; limit or get rid of mortgage interest deduction; limit the involvement of corporations in single family housing, etc. But none of this will happen, because significant change is not possible in the US given the limitations of the constitution, and the weaponization of those limitations.
Interesting discussion. The questions being discussed here impact everyone. H is absolutely correct. “It strips people of their agency. What it says to people is this: You know you can’t afford this, and we know you can’t afford this, but we’ve figured out a way to let you buy it anyway.” Coincidentally, the other day I commented with a real-life example on a very similar theme here: https://heisenbergreport.com/2022/07/20/nobody-can-afford-anything/
The banks control the playing field, and they seem to believe that Americans will abide with a heavy yoke draped over their shoulders, and Americans have confirmed their beliefs. I worked at JPM and at BMO. I’m sure the banks measured the risk of loss from such loans and determined it was acceptable and would yield profit for their institutions. From the perspective of banks, it was a manageable risk. But as I noted in the comment referenced to the linked post above, I saw the same business practice used by the banks in the 1970s, offering to fund my college education.
I believe that both banks and borrowers – all of us, in fact – enjoy a certain amount of confidence, even hubris, because we are part of an historically strong and persistent American economic system. But part of our strength resides in checks and balances in the system to control losses. Do we all exercise the same due diligence applied by the banks when they expanded their lending policies back in the 70s?
In our wonderful political system, we have the freedom to make bad decisions. But this is also a capitalist system, and the buyer needs to beware. Whether taking on the financial burden of a mortgage, a commercial enterprise, a yacht, or a used car, it is a responsibility. And forgoing that responsibility can have terrible consequences for any individual life. Default means the bank can legally take everything you have to satisfy the loss imposed by the contract. Having the freedom to make decisions doesn’t mean we should always get the shiny object of our temporal affections.
To your point, H. “If homeownership is something that we want to be universal, then we need to figure out a way to pay people enough money for their labor and/or reduce the price of homes, such that they (people) can buy them (homes) on financial terms that make common sense.” Taking these steps means that policy and politics must be enabled. But there’s a whole lot of contentiousness on the political scene. How change like this gets from point A to point B is uncertain, though not impossible. If we’re lucky, the Trump effect will diminish as his legal troubles increase, and the political wind will begin to blow in the direction of cooperative discussion across parties. It’s a “wait and see” proposition.
Continuously bailing out banks is not the answer. Neither is a us ten year yielding 55 basis points. Creating supply is the answer and this takes a long time- here’s an interesting one. A Builder in Stockton donated a large parcel of land in return for the right to build 120 houses. The City council said said yes. Looked great- then the water company said no new clients we don’t have enough water. The world is round…..