Housing Prices: Still Too High


Home prices across the country fell something like 13 per cent drop from a year ago, perhaps the worst decline since the Great Depression. Unfortunately, that doesn’t mean that homes are cheap or that home prices are set for a comeback. Far from showing a housing panic, these plunging prices represent a reversion to normal pricing. And we still have a way to go down before we reach normal.

Housing economists and authors Susanne Trimbath and Juan Montoya explain that when housing prices are measured against income, home prices are still too high. From New Geography:

Now that prices are falling quicker than incomes, there should be a surge in new buyers. Since 1975, whenever the ratio of mortgage payments to income falls, home sales usually rise. The correlation coefficient indicates that for every 1% improvement in affordability there is a 2% increase in home sales. But now, something is wrong. In 2007, for every 1% improvement in affordability, home sales fell by 2%.

Part of the problem is that prices still are simply too high. Even as recently as August 2008, the median home price was still historically high in comparison to median income – about 4 times. It takes lower rates than in the past for a family with the median income to afford the median priced house. This means that homes are less affordable today than they were 6 years ago.

The last time that home sales fell as they became more affordable was in the 1990s at a time known as a “credit crunch.” At that time, the ratio of home prices to income was actually lower – 3.8 times in September 1990 compared to 4.3 in September 2008. The difference was that between 1990 and 1992 mortgage interest rates averaged a hefty 9.26%. In the last 3 years, the average was 6.14% and while the words “credit crisis” bled in headlines around the world, the regular mortgage interest rate barely budged.

This would suggest that the recession could inflict further pain on homeowners. If income drops, home prices will be even further elevated in comparison. This could set the stage for another huge drop in home prices as the market struggles to reach something like a normal level of housing affordability.