Median Household Income & Housing Prices, Debt Service Ratios & Risk Mitigation
Nattering Naybob Running Amok comments...
I found this in one of your earlier posts, and the common sensedness of it whacked me across the forehead like a 2x4:
"We often hear that these problems are caused by the sub-prime crisis in the US. But it's worth remembering that whilst overly loose lending practices in the US
pushed house prices to six-times the average salary, in the UK house prices are now nine-times the average salary.
Like we keep saying, when the prices get back down to what salary/rent's will support, prices will stabilize."
It begs a question: If six times is too many, what would be more reasonable?
We Natter back... On 12/15/05 we breech the subject:
"Personal wages/income do not support the current prices, nor do they support the rental rates necessary at these price levels."
On 09/25/06 we discuss a laughable liar, the nature of the unwind and give first mention of cut all you want AKA no amount of rate cutting can stop the decline:
"David Lereah, chief economist for NAR: "The price drop has stopped the bleeding. Sales have hit bottom... I am confident the housing sector is picking up.
Mr. Lereah is very optimistic, because he is paid to be so. Jobs and incomes have been shrinking during the boom phase, these were "good times".
A recession tied directly to the cause of the boom lies in wait. The "steroid like" debt fueled consumer spending spree will end and decline.
No amount of money printing & creative financing can overcome this. Why? like steroids, doubling the maintenance dose won't get the same results because
the "demand" was artificiallly stimulated by loose money and low rates vs naturally by rising incomes & rents."
On 10/30/07 in Reversion to the Mean we discussed...
a lack of risk mitigation (originate to sold, rather than to hold) and how 2001 price levels might be the equilibrium point.
And finally in Feb 2008, in What is It Really Worth?
Average wage $17.92 hr, median California household income $54K, median California price Aug 07 $589K; yields 11X.
Goldman Sachs thinks 7.5X might be justified at $350 - $380K.
However... upon further review... and much nattering in our head...
Based on median US household income 2006 $48K and using the loosest of old school underwriting ratios at 33/40 (reserved for seasoned low risk clients).
Meaning 33% of gross income goes to mortgage service, and 40% to service mortgage plus all other consumer debts.
These were the ratios used in the day of originate to hold (the loan is staying in the portfolio), rather than originate to sold (the loan is being sold downstream).
In addition, 5% down was the minimum with tax and PMI impounds (using a tighter 20/25% ratio). Also, no down 100% or 110%, and interest only loans were unheard of.
Under this criteria, with 20% down and a fixed 30 yr at 6%; max purchase price could be $220K or 4.5X.
The Nattering One would be even more conservative and use 25/33 on younger, 1st time or riskier borrowers.
This lowers the bar to $165K or 3.5X. Somehow this resonates correctly from a historical perspective. How and Why?
Left Median Household Income; Right Average Home Price.
1965: $6K; $14K = 2.3X
1970: $9.5K; $23K = 2.4X
1975: $12K; $35K = 2.9X
1980: $18K; $62K = 3.4X
1985: $24K ; $75K = 3.1X
1990: $30K; $92K = 3X
1995: $34K; $110K = 3.23X
2000: $42K; $139K = 3.3X
2005: $46K; $219K = 4.75X
Note the 1970 to 1980 and 2000 to 2005 spikes.
It would seem that 3X to 3.5X would be the historical norm 1975 to 2000, which correlates with the 25/33 ratio.
Had anyone from my era and background been responsible for the underwriting criteria, or mitigating the risk, we would not be in the mess we are.
Sources: Median Household Income Census Bureau; US Median Home Price NAR.
I found this in one of your earlier posts, and the common sensedness of it whacked me across the forehead like a 2x4:
"We often hear that these problems are caused by the sub-prime crisis in the US. But it's worth remembering that whilst overly loose lending practices in the US
pushed house prices to six-times the average salary, in the UK house prices are now nine-times the average salary.
Like we keep saying, when the prices get back down to what salary/rent's will support, prices will stabilize."
It begs a question: If six times is too many, what would be more reasonable?
We Natter back... On 12/15/05 we breech the subject:
"Personal wages/income do not support the current prices, nor do they support the rental rates necessary at these price levels."
On 09/25/06 we discuss a laughable liar, the nature of the unwind and give first mention of cut all you want AKA no amount of rate cutting can stop the decline:
"David Lereah, chief economist for NAR: "The price drop has stopped the bleeding. Sales have hit bottom... I am confident the housing sector is picking up.
Mr. Lereah is very optimistic, because he is paid to be so. Jobs and incomes have been shrinking during the boom phase, these were "good times".
A recession tied directly to the cause of the boom lies in wait. The "steroid like" debt fueled consumer spending spree will end and decline.
No amount of money printing & creative financing can overcome this. Why? like steroids, doubling the maintenance dose won't get the same results because
the "demand" was artificiallly stimulated by loose money and low rates vs naturally by rising incomes & rents."
On 10/30/07 in Reversion to the Mean we discussed...
a lack of risk mitigation (originate to sold, rather than to hold) and how 2001 price levels might be the equilibrium point.
And finally in Feb 2008, in What is It Really Worth?
Average wage $17.92 hr, median California household income $54K, median California price Aug 07 $589K; yields 11X.
Goldman Sachs thinks 7.5X might be justified at $350 - $380K.
However... upon further review... and much nattering in our head...
Based on median US household income 2006 $48K and using the loosest of old school underwriting ratios at 33/40 (reserved for seasoned low risk clients).
Meaning 33% of gross income goes to mortgage service, and 40% to service mortgage plus all other consumer debts.
These were the ratios used in the day of originate to hold (the loan is staying in the portfolio), rather than originate to sold (the loan is being sold downstream).
In addition, 5% down was the minimum with tax and PMI impounds (using a tighter 20/25% ratio). Also, no down 100% or 110%, and interest only loans were unheard of.
Under this criteria, with 20% down and a fixed 30 yr at 6%; max purchase price could be $220K or 4.5X.
The Nattering One would be even more conservative and use 25/33 on younger, 1st time or riskier borrowers.
This lowers the bar to $165K or 3.5X. Somehow this resonates correctly from a historical perspective. How and Why?
Left Median Household Income; Right Average Home Price.
1965: $6K; $14K = 2.3X
1970: $9.5K; $23K = 2.4X
1975: $12K; $35K = 2.9X
1980: $18K; $62K = 3.4X
1985: $24K ; $75K = 3.1X
1990: $30K; $92K = 3X
1995: $34K; $110K = 3.23X
2000: $42K; $139K = 3.3X
2005: $46K; $219K = 4.75X
Note the 1970 to 1980 and 2000 to 2005 spikes.
It would seem that 3X to 3.5X would be the historical norm 1975 to 2000, which correlates with the 25/33 ratio.
Had anyone from my era and background been responsible for the underwriting criteria, or mitigating the risk, we would not be in the mess we are.
Sources: Median Household Income Census Bureau; US Median Home Price NAR.
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