There are many ways to look at housing affordability. A prior post evaluated affordability by comparing payment required to income available over a 43-year time frame.
An alternative methodology is to look at monthly house payments after adjusting them for inflation. At Colorado Home Realty (CHR), we conducted an affordability analysis recently using this complementary approach. Since this analysis takes inflation into account, let’s review the concept of inflation.
Inflation causes the purchasing power of a dollar to decrease over time. A gallon of gas cost 53 cents in 1974. Today, you’ll pay $2.25 for that same gallon. You could buy almost 2 gallons of gas for a dollar in 1974, but that same dollar now won’t even buy half a gallon. A dollar has less purchasing power today than it did in 1974. That loss of purchasing power is called inflation.
A common way to measure inflation is the Consumer Price Index (CPI). The CPI can be used to adjust the dollars spent in different years so that they both represent the purchasing power of today’s dollar.
Let’s see how it works when applied to mortgage payments on a house. The average single family home had a price tag of $34,722 in 1974. Interest rates averaged 9.19% that year. With 10% down on a 30-year mortgage, a buyer paid $256 for principal and interest on the home loan.
However, dollars were worth a lot more in 1974. It takes $4.87 today, according to the CPI, to buy what a buck would buy you in 1974.
If you want to know the cost of the 1974 home loan payment in terms on the purchasing power of today’s dollar, you’ve got to multiply the 1974 payment by 4.87. You discover that the 1974 payment of $256 is equivalent to $1,247 in today’s dollars.
Think of it this way: Having $1,247 today is equivalent to having $256 in 1974. If you have $1,247 today you can buy just as much stuff as you could if you had $256 in 1974.
The CHR affordability study computed the principal and interest payment for the average single family home in metro Denver from 1974 through 2016. The calculations assumed a 10% down payment and a 30-year loan at the average interest rate for a given year. That payment was then adjusted for inflation to reflect its equivalent value in 2016.
Adjusting costs for inflation over a number of years is a standard economic practice that is required to produce an apples-to-apples comparison.
The results are shown on the accompanying chart. The lowest payment was $1,165 in 1975, while the highest occurred in 1981 when an owner would have paid the equivalent of $2,782 in terms of today’s dollars to buy the average home.
The average payment over the entire 43-year study period was $1,744. The payment for the average single family home in 2016 is $1,816, within spitting distance of the overall average.
Once again, seeing that the current house payments are in line with a long-term historic norm gives us confidence that we are not in a crazy, out of whack market despite historic high prices. We are not in a bubble.
Compliments : Mike Cooke @ Colorado Home Realty