Housing affordability in southern California has been a problem for quite some time now. California Veterans have an advantage of other home buyers since the VA loan program does not require a down payment. The high home appreciation rates in southern California can be attributed to several reasons: less housing inventory for sale, high demand for housing due to population increase, low interest rates, rising rents, and the fact that California has a lot to offer. California has great weather. Depending on the location within California you can be in the mountains or at the beach within a few hours. You can ski and surf on the same day if you really want to. People want to live in California. A lot of people. That creates a high demand for a limited supply of homes. And for all of you economists out there, an imbalance in supply and demand that is heavy on the demand side results in rising prices.
Are Southern California Home Unaffordable?
Housing affordability in Southern California is a hot topic lately. The housing market has been on an upswing for the last several years, and housing prices have been appreciating at a fast pace since the 4th quarter of 2020. But rent is also on an upswing. Interest rates are low too which has helped fuel the real estate market. Low rates have made this a great time to buy a home and Lock in" a payment versus continuing to rent and have your housing cost rise every year. At least with a mortgage, you will lock in your payment for 30 years while rents keep going up year after year.
In order to determine whether homes are unaffordable or not, we must first decide what affordable means to us and how much we can afford every month without sacrificing other aspects of our lives such as food and clothing expenditures.
However, housing affordability is important because it affects not only those who want to buy their home but also renters because if they were able to save money for a down payment, they would be able to buy their own home and start paying rent towards a mortgage rather than throwing money away every month.
So while housing affordability is important, it isn’t everything because if you have to sacrifice your life in order to pay bills for housing then you aren’t living well at all! If housing affordability is your main concern, then you may want to consider moving away from southern California because housing prices are higher in California than in most other parts of the country.
In fact, housing prices in Southern California increased by a staggering 18% over the past year.
The chart above shows that even with the run up in home prices, the percentage of disposable income going towards mortgage payments is still less than in previous years going back to 1980. This has been helped greatly by low interest rates.
Housing is Expected to Remain Hot
Home prices increased between 18% and 30% in the last 12 months depending on where in California you are. Home prices can't maintain the current levels of appreciation, but that doesn't mean there will be a crash. The media has been reporting that the market has slowed down. But slowed down from what? In early 2021 it was not uncommon to hear about 20, 30, even 50 offers on one home. How do you even compete as a buyer in that situation? Now, as we approach the 4th quarter of 2021, the "slowdown" means there may only be 3 or 5 offers on a home. Corelogic is projecting appreciation in 2022 of 4% to 5%. That is still a very healthy appreciation and is not a "crash".
The Affordability Question
Affordability factors income, interest rates, and home prices. There are several "Affordability Indexes" that are calculated by different experts and institutes. Affordability can be very different for one family versus another. A young couple with no kids who are expecting continued income increases may have no problem paying a higher mortgage payment than a couple with young children and/or education expenses. Some people are willing to put more of their income into a mortgage payment versus someone else who wants to travel and go out to restaurants. Everyone's situation is different. But let's look at affordability and dive into the numbers.
When taking into account inflation and comparing past mortgage payments compared to income, it is more affordable now than at any time between 1975 and 2005.
The chart above shows there have only been two times in the past 45 years when it was less expensive to buy a home than it is right now.
- 2010 - After the mortgage meltdown and housing crisis, property values dropped quickly. In 2010 one third of all sales were foreclosures or short sales. There was a supply and demand imbalance in favor of demand, which resulted in prices dropping. Homes were very affordable.
- 2020-Last year - Yes-and this is why people are worried. It was more affordable last year than this year.
This shows that although homes are less affordable this year than in 2020, we are still more affordable right now compared to all but two years over the last 45 years when including inflation into the equation.
What if we also factor in Equity to the Affordability Question?
One of the biggest reasons to own a home is to grow your net worth. You do that by paying your mortgage balance down and by owning a home that is appreciating in value. Let's compare someone renting a home for $2,500 with a $50 insurance payment to someone purchasing a $700,000 with 5% down. In year one you'll see in the chart below the payment difference is $2,550 (rent) versus $3,745 (own). But more importantly, look at the Net Monthly Payment comparison. The Net difference is less since approximately $1,179 of the mortgage payment is principal. Principal paydown goes straight to net worth. It's like putting money into your savings account, except this is putting it into the equity of your home.
The chart below shows shows the full payment breakdown, also know as the PITI. Principal & Interest, taxes, and insurance. And in this case, Mortgage Insurance since the down payment was less than 20%.
The chart below shows a Net Worth comparison for renting versus owning after 15 years. Total rent payments over 15 years are $656,357. That assumes the first year rent of $2,550 with 5% annual increases. 15 years of PITI payments would be $649,617. $261,979 of the PITI is Principal, which just helps push Net Worth higher. Plus, using the same 5% appreciation rate that we assumed for rent increases, and the total equity in the home is $1,052,229 after 15 years.
The sooner a potential home buyer can purchase a home and get off the rent hamster trail, the sooner your Net Worth will grow. And it's even easier for California Veterans since the VA loan program does not require a down payment. The first step in the California home buying process is to contact a California mortgage specialist who can prepare a custom Purchase Analysis based on your home buying goals, budget, and wants and needs. From there, you should get PreApproved for a mortgage BEFORE you begin making offers on homes. Some lenders are more adept at working with home buyers while some only focus on refinancing. Make sure to find a California Loan Officer who can guide you through the homebuying process and answer all of your home financing questions.
Authored by Tim Storm, a California VA Loan Officer specializing in VA Loans. MLO 223456. – Please contact my office at Fairway Independent Mortgage Corporation NMLS 2289. My direct line is 714-478-3049. I will prepare custom VA loan scenarios that will be matched up to your financial goals, both long and short-term. I also prepare a Video Explanation of your scenarios so that you are able to fully understand the numbers BEFORE you have started the loan process.