Housing Prices Versus Income

Housing Prices Versus Income

It seems logical that average housing prices would be correlated to average income of an individual. You would expect housing prices to rise as income rises, and housing prices to decline as income declines. This seems like a simple supply and demand relationship. History has showed us that this simple correlation is not always true.

As shown in the below chart, home prices were high relative to income in 1990. In 1991, a recession took place and home prices decreased over the next ten years. This housing phenomenon is referred to as a real estate bubble. A real estate bubble is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in valuations of real property such as housing until they reach unsustainable levels relative to incomes and other economic elements, followed by a reduction in price levels.

Starting in the early 2000’s, housing prices increased rapidly compared to income and hit a high in 2006. There are a number of explanations for the sudden increase in home prices. Many economists theorize that the low federal funds target rate in the early 2000’s led to an increase in real estate financing activity. As a result, home prices began to increase faster than income and the bubble was intensifying. At this point, individuals who were making the median household income could not afford to buy a median priced home. In order to qualify buyers for loans, lenders loosened credit regulations and encouraged risky mortgage products like interest-only loans, negative amortization loans and ARM loans. This made it easier to get a mortgage, but much harder to keep it.

Between 1997 and 2006, the price of the typical American house increased by 124%. During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006. This housing bubble...