But does it make sense to look at everything in nominal terms?
Sure, deflating incomes and housing costs by the same factor wouldn't change your analysis. But your analysis is not taking into account non-housing costs, which matter if we are concerned with housing affordability.
For example, even if housing costs and incomes are rising at the same pace, if non-housing costs are soaring, then housing is still becoming less affordable—it's taking up a rising share of household incomes post food, car, clothing, and other necessities.
I think that's a good question. A quick look shows that only childcare, college tuition and medical expenses have been growing faster than hourly wages in the past 20 years: https://www.aei.org/carpe-diem/chart-of-the-day-or-century/. So things might be more difficult for households with kids where both parents are employed and don't have grandparents nearby to help with childcare.
Thought experiment in real dollar terms, likely wrong:
You're an apple farmer in a 1980 economy that only consumes apples. Apples are $1 (high quality apples) a pop and you farm 100 of them a year.
A house is going for 250 apples today (1980), so $250 dollars. You head to the bank for that full $250 mortgage.
They say, hey, inflation expectations are high right now at 17% so the mortgage rate is 20%, paid annually, but if you're still interested we can offer you something over 25 years.
Shoot, you say, looking at your early MS Excel prototype model, that's $50.5 dollars/apples a year, half my current income this year! But then you notice - with inflation, that'll only be 43 apples at the year 1 payment, 37 at y2, 23 apples at y5, etc. In apple terms, the payment is dropping by over 14% apples a year. In ten years, the NPV of my mortgage will just be 49 apples, payments just 10 apples.
Loan payments in high inflationary environments need to be really front loaded because everything later in time gets nulled; the first payment amount might be high but it becomes nominal quick. In terms of your output, you'll be spending 290 apples over the mortgage term at this 20/17 scenario. Quite a bit better than paying 2x higher priced (600+) at a lower interest rate in 2022, unless you think there is something countervailing going on with opportunity cost.
I appreciate the transparency of your methods and assumptions, but I think you need to be clear you are measuring the cost only of the first year of mortgage payments relative to income. However while the final price is fixed and most mortgages have fixed interest rates to the upside they effectively don't to the downside. If you bought in 1981 with a 17% interest rate and then refied in 1985 at a 10% rate (eyeballing your graphs for the example) then you have almost a 50% reduction in your nominal payment. That would mean 5 years of rough payments as a % of income followed by 25 years at progressively lower rates against progressively higher income (and refi opportunities would have existed before that 5 year period). Additionally home appreciation means much lower risk of bankruptcy, realistically while 1981 might have been the most difficult year to pay for a mortgage taken out in that year it would also have likely been the best year to purchase a house with debt.
If I'm reading this correctly, you reproduced Shib's graph yourself under price-to-income ratio, so in some sense it's bad, but as long as you can get a mortgage, you're still OK? I wouldn't really call that misleading. He did accurately label his graph.
1) Historically between 70 and 80% of homes were bought with a mortgage and I suspect a large chunk of all-cash purchases have been done by selling your previous home first, which also means you don't care as much about the price-to-income ratio. So for a large majority of Americans its the mortgage payments that matter, not the absolute value in dollars. That being said, I now realize I didn't take the 10% downpayment requirement into account - I'll have to post an update for that.
2) Shib's graph starts from 3 rather than from 0, which makes the stat look much worse than it really is.
3) I didn't quite replicate his numbers. My calculation shows that between 2000 and 2022, the price-to-income ratio went up from 3.3 to 4.6 (+40%). His numbers show it went up from ~4.1 to ~7.5 (+80%).
Nice article, I sub’s. When the inflation rate is so high like in the 70s/80s it devalues the principle in real terms rather quickly. Assuming your wage grows with the inflation rate the affordability come about very quickly.
I’d be very interested to see global data extended to include China and SE Asia. As far as I can tell their price to income ratios are even more out of control
Excellent post.
But does it make sense to look at everything in nominal terms?
Sure, deflating incomes and housing costs by the same factor wouldn't change your analysis. But your analysis is not taking into account non-housing costs, which matter if we are concerned with housing affordability.
For example, even if housing costs and incomes are rising at the same pace, if non-housing costs are soaring, then housing is still becoming less affordable—it's taking up a rising share of household incomes post food, car, clothing, and other necessities.
I think that's a good question. A quick look shows that only childcare, college tuition and medical expenses have been growing faster than hourly wages in the past 20 years: https://www.aei.org/carpe-diem/chart-of-the-day-or-century/. So things might be more difficult for households with kids where both parents are employed and don't have grandparents nearby to help with childcare.
Thought experiment in real dollar terms, likely wrong:
You're an apple farmer in a 1980 economy that only consumes apples. Apples are $1 (high quality apples) a pop and you farm 100 of them a year.
A house is going for 250 apples today (1980), so $250 dollars. You head to the bank for that full $250 mortgage.
They say, hey, inflation expectations are high right now at 17% so the mortgage rate is 20%, paid annually, but if you're still interested we can offer you something over 25 years.
Shoot, you say, looking at your early MS Excel prototype model, that's $50.5 dollars/apples a year, half my current income this year! But then you notice - with inflation, that'll only be 43 apples at the year 1 payment, 37 at y2, 23 apples at y5, etc. In apple terms, the payment is dropping by over 14% apples a year. In ten years, the NPV of my mortgage will just be 49 apples, payments just 10 apples.
Loan payments in high inflationary environments need to be really front loaded because everything later in time gets nulled; the first payment amount might be high but it becomes nominal quick. In terms of your output, you'll be spending 290 apples over the mortgage term at this 20/17 scenario. Quite a bit better than paying 2x higher priced (600+) at a lower interest rate in 2022, unless you think there is something countervailing going on with opportunity cost.
That's a great point and I've addressed it with new graphs here: https://nsokolsky.substack.com/p/additional-data-on-historical-housing
I appreciate the transparency of your methods and assumptions, but I think you need to be clear you are measuring the cost only of the first year of mortgage payments relative to income. However while the final price is fixed and most mortgages have fixed interest rates to the upside they effectively don't to the downside. If you bought in 1981 with a 17% interest rate and then refied in 1985 at a 10% rate (eyeballing your graphs for the example) then you have almost a 50% reduction in your nominal payment. That would mean 5 years of rough payments as a % of income followed by 25 years at progressively lower rates against progressively higher income (and refi opportunities would have existed before that 5 year period). Additionally home appreciation means much lower risk of bankruptcy, realistically while 1981 might have been the most difficult year to pay for a mortgage taken out in that year it would also have likely been the best year to purchase a house with debt.
Yes, that's a valid point, I'll add a graph of "lifetime expected payments" in an update post to address this.
If I'm reading this correctly, you reproduced Shib's graph yourself under price-to-income ratio, so in some sense it's bad, but as long as you can get a mortgage, you're still OK? I wouldn't really call that misleading. He did accurately label his graph.
1) Historically between 70 and 80% of homes were bought with a mortgage and I suspect a large chunk of all-cash purchases have been done by selling your previous home first, which also means you don't care as much about the price-to-income ratio. So for a large majority of Americans its the mortgage payments that matter, not the absolute value in dollars. That being said, I now realize I didn't take the 10% downpayment requirement into account - I'll have to post an update for that.
2) Shib's graph starts from 3 rather than from 0, which makes the stat look much worse than it really is.
3) I didn't quite replicate his numbers. My calculation shows that between 2000 and 2022, the price-to-income ratio went up from 3.3 to 4.6 (+40%). His numbers show it went up from ~4.1 to ~7.5 (+80%).
Nice article, I sub’s. When the inflation rate is so high like in the 70s/80s it devalues the principle in real terms rather quickly. Assuming your wage grows with the inflation rate the affordability come about very quickly.
I’d be very interested to see global data extended to include China and SE Asia. As far as I can tell their price to income ratios are even more out of control
I'll take a look and see if I can find good data on China and other countries going back as far into history.