Homeowners win in the current housing market.
Stephanie Keith/Bloomberg
About the author: Laurie Goodman is vice president for housing finance policy and the founder of the Housing Finance Policy Center at the Urban Institute.
House prices have increased 81.5% in the United States over the last decade, including 17.6% in the last year alone. This robust home price appreciation is partly due to the acute housing shortage that developed in the aftermath of the Great Recession, when new home building slowed below the level necessary to provide for new household formation. This shortage has only worsened in the last year, as interest rates have dropped in response to the Covid-19 pandemic, resulting in increased demand from potential homebuyers who can suddenly afford to pay more for a house.
In this market, who wins and who loses? And does it promote or impede economic and racial equity?
Simple: The winners are homeowners. They get to keep any accumulated home price appreciation. This both increases their net worth and allows them an additional source of equity they can borrow against as needed. They may also be able to take advantage of today’s low rates to refinance their mortgage, reducing their monthly payment.
Unlike homeowners, renters lose in this market. At least those seeking to become homeowners do. For starters, the increase in home prices means it costs more to buy a home. And yes, today’s low interest rates help to offset that increased cost, but home prices have increased more than interest rates have decreased. As a result, today’s homebuyers face a higher monthly payment on the same home than they would have in early 2020, before the start of the Covid-19 pandemic.
Another challenge this market presents involves qualifying for a mortgage. Two of the criteria mortgage lenders use to qualify borrowers are the loan-to-value ratio, which is the size of the mortgage loan as compared to the value of the home, and the debt-to-income ratio, which is the value of the borrowers’ total monthly debt payments as a percentage of their total monthly income. In the current market, borrowers may struggle more to satisfy lenders’ requirements regarding these ratios.
As home prices increase, so do homebuyers’ down payments. The larger the down payment, the smaller the mortgage loan, and thus the lower the loan-to-value ratio, making it easier to qualify for the mortgage. In the current economy, saving for a down payment may be especially difficult because inflation is outstripping wage growth. People are forced to spend more on everyday needs, especially their rental payments, which are increasing rapidly in some markets, and leaving less money to save for a down payment on a home.
Moreover, because we know monthly mortgage payments have increased in the current market, borrowers will have a higher debt-to-income ratio. That is, unless the borrower’s income has also increased at least as much as home prices. Unfortunately, this isn’t the case for most renters. Although home prices increased 17.5% in the previous year, average hourly earnings only grew by 3.5%. Consequently, most borrowers are likely to have a higher debt-to-income ratio, making it harder to qualify for a mortgage.
Taken together, these factors make it much less likely for today’s renters to achieve homeownership. And that’s a big problem, in part because the financial benefits of homeownership are significant. Assuming the homeowner has a fixed-rate mortgage, she has guaranteed herself the same monthly payment for the life of the loan. Yes, property taxes, insurance and home maintenance costs may fluctuate, but they are the minority of the monthly payment. The vast majority of the payment—the principal and interest—remains fixed, producing a housing payment that is not only predictable, but also immune to inflation. That’s a particularly useful benefit in today’s market, when inflation is rising.
Unfortunately, renters lack this predictability and stability. Instead, a renter can expect her rent to increase each year, likely faster than the overall rate of inflation given today’s tight housing supply. Plus, the renter is at the mercy of the landlord. Should the landlord decide not to renew the lease, the renter is forced to move, potentially requiring children to change schools and workers to find different jobs or accept longer commutes.
Owning a home is the single best way to build wealth. Housing is a leveraged investment, with the median new buyer putting down about 5% of the home’s value and borrowing the remainder. A modest 3% increase in the value of the home is the equivalent of a nearly 60% return per annum on the initial investment. Thus, it’s not surprising that the median homeowner has about 40 times more wealth than the median renter, about $255,000 versus $6,300, of which about half is housing.
But it is important to note that the demographics of homeowners are significantly different than those of renters, differences that fuel our nation’s self-perpetuating cycle of economic and racial inequity. Specifically, homeowners earn more money. According to the 2019 American Community Survey, the median income for homeowners is $82,000 as compared to a median income of $42,500 for renters. And homeowners are more likely to be white. About 28% of non-Hispanic white households are renters, as compared to 58% of Black households and 52% of Hispanic households.
This means the people who stand to benefit most in the current housing market are those who are white, more affluent, or both. On the other hand, people of color, those with lower incomes, or individuals who fall into both groups are more likely to struggle. The consequences of such disparities are both obvious and concerning. They include further entrenching the economic gulfs that already exist between those with more money and those with less, and between people of color and white people. Today’s higher home prices are only going to make it that much harder for people of color and people living on low and moderate incomes to catch up by impeding their access to affordable homeownership.
Today’s housing market is constraining mobility, especially for people moving from lower-priced to higher-priced areas. For all the talk about people no longer moving to cities with high housing costs, the fact is that house prices are also increasing quickly in formerly affordable cities that offer good jobs, like Austin and Denver. If people can’t afford to live in these cities, they can’t move there. And that’s an economic loss, both to the workers who can’t relocate and also to the broader economy in need of those workers.
We can address some of these challenges by creating additional housing. This will slow the rate of home price appreciation and allow more renters to become homeowners, in turn helping both to alleviate the housing shortage that currently plagues virtually every community in America, and to level the economic playing field for the millions of low-income renters and renters of color who can’t make the critical transition to homeownership in the current market.
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