Low interest rates and rising incomes have made houses more affordable than they were 10 years ago, suggesting that talk of a national real estate bubble might be exaggerated, according to a new study by the Federal Reserve Bank of Chicago.
It took less than 16 percent of the median household's income to cover the monthly mortgage payment on a home with the median sale price last year, the study by senior economist Richard Rosen found. That compares with 20 percent in the mid-1980s and 18 percent in the early 1990s.
"The increase in housing has come at the same time as mortgage rates have declined and incomes have increased," Rosen wrote in the Chicago Fed Letter published last week. "These two factors have kept housing affordability for the United States as a whole roughly constant as housing prices have increased."
The study echoes comments by other Fed officials including Chairman Alan Greenspan that, while some housing markets appear to be overheated, it's unlikely there is a national housing bubble that will burst, sending real estate values plummeting.
If mortgage rates rise to 6.5 percent from last year's average 5.8 percent, and people continued to spend 15.8 percent of their income on monthly payments, housing prices would probably fall 6.5 percent, Rosen wrote in the study. If rates go higher, values could decline further, he said.
The overall rise in house prices also does not take into account the trend toward larger, more luxurious homes, said Brian Bethune, director of U.S. financial economics at consultant Global Insight Inc. in Lexington, Mass.
"These upscale homes tend to have many features - i.e., a three-car garage - that provide a significant boost to the perceived value of home services provided," Bethune said. "On a quality-adjusted basis, home prices are not moving up by as much as the top-line numbers would suggest."
The Chicago Fed study said housing affordability in some markets, including Boston, New York and San Francisco, is far lower than the national median. According to his "mortgage-servicing index," the median household in San Francisco spent about 45 percent of its income on housing in 2004.
Last month, Greenspan said the housing market was showing signs of unsustainable price speculation and "froth" from rapid sales. "It's pretty clear that it's an unsustainable underlying pattern," he told the Economic Club of New York May 20. "People are reaching to be able to pay the prices to be able to move into a home."
Although "we don't perceive that there is a national bubble," he said, "it's hard not to see that there are a lot of local bubbles."
Still, some economists point to the rise in housing prices as a sign that Greenspan and the Fed need to keep boosting interest rates. The Office of Federal Housing Enterprise Oversight reported Wednesday that resale prices rose 12.5 percent in the first quarter.
"It will be difficult to persuade the FOMC [Federal Open Market Committee] that the funds rate is anywhere near a 'neutral' level when a mortgage financing boom is contributing to double-digit gains in home price inflation," said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, N.J.