In our last article, Is Atlanta Housing Really 8% Undervalued?, we talked about the study that Trulia released and the Wall Street Journal wrote up about the linkage between income and housing prices between the pre-boom years of 1985-2000 and today’s current price-to-income ratio. The study was no doubt an interesting look at our housing markets today and one that I have not seen illustrated in this way. So what does the study really tell us?

The first thing that most home sellers are thinking is that prices are too low now so they should list their homes higher than other homes that have recently sold, right?  That’s the danger of these headlines because, in most areas of Atlanta, the last sale in the neighborhood is still the “Ceiling”, meaning the top price anyone will pay, so if you interpret this study that way, you will end up with an over-priced listing that will not sell in this market.

I think what this study means is that the price of real estate has come down from the peak (which in the Atlanta real estate market was the third quarter of 2004) and that people are not leveraging themselves as much as they did back during the boom.  What it doesn’t look at is the impact that our extremely low interest rates have had on markets. With rates hanging below 5% for quite some time now (compared t0 the 80′s and 90′s which was twice that), this study does not exactly compare the affordability of house.

For instance, in 1985, the average interest rate for a 30 year mortgage (according to FreddieMac.com) was 12.43% compared to today’s rate which is something like 4.25%. For argument’s sake, if I made $100k back in 1985 and bought a $300k home by mortgaging the whole thing (which was not possible back then), I would have been paying $3185 per month in principal and interest (30 year fixed amortized mortgage).  If I’m making $100k today and buy a $300k home the mortgage on the same $300k would be $1475.  That’s almost twice as affordable on the same income!  If we really want to understand this, a better study would be to look at the percentage of people’s income they were paying for their house payment.  There is a study done by the National Association of Realtors called the Home Affordability Index that is released on a quarterly basis.

Let’s back up a minute now and consider the difference in the lending environments between 1985  and 2000 compared to now.  The down payment requirement in the 80′s was pretty much 20% of the price of the home.  Today most people are putting down between 5% and 10% for a conventional loan, and if you are buying a home via FHA financing, you can put down as little as 3.5%.  Let’s illustrate then what the difference might look like between your standard loan in 1985 with a 20% down payment and your average run of the mill loan today with 10% down at 4.25%

As you can see, not only are people paying less of a percentage of their income on the down payment to purchase the home, but they are paying considerably less of their income on their monthly payment, which in the end, is what a home buyer is really buying.  I don’t know about you, but to me, this makes a pretty strong case to buy a home right now doesn’t it?