How We Track Housing Affordability
Affordable housing has emerged as a critical issue impacting individuals, families, and communities in South Dakota and across the United States. While the overall US housing market has experienced a noticeable slowdown in recent months, South Dakota homebuyers continue to face significant swings in affordability, with listing prices remaining elevated. Between April 2022 and April 2023, listing prices in South Dakota surged by 8.4%, outpacing the national average of 2.7%. These substantial price increases, coupled with a steep 1.14 percentage point increase (22%) in mortgage rates over the same period and dynamic income conditions, underscore the need to assess how these factors impact housing affordability. This article provides an analysis of housing affordability in South Dakota and neighboring Midwest states and the US. Furthermore, we delve into the factors driving these rapid changes in affordability, examining the interplay of housing prices, mortgage rates, and wages as they continue to fluctuate.
What is the Housing Affordability Index?
The Housing Affordability Index (HAI) is a composite measure that consists of several vital housing market statistics, including listing prices, mortgage interest rates, and family income reported from the Federal Reserve Bank, US Census Bureau and Realtor.com, and constructed using the same methodology as the National Association of Realtors. The HAI provides a way to track whether housing is becoming more or less affordable for the typical household over time.
More specifically, the HAI measures affordability by comparing median family income relative to the recommended level of income needed to purchase a median-priced home, often referred to as qualifying income in the world of real estate. Mathematically, we express the HAI as:
HAI = (Median Family Income ÷ Qualifying Income) × 100,
where Qualifying Income is the recommended income necessary to ensure that the monthly mortgage payment adheres to the “golden rule of lending”, which suggests that a monthly mortgage payment should be no more than 25% to 30% of gross monthly income.
We construct the HAI using a “golden rule” at 28%, which means an affordable mortgage would cost the typical family no more than 28% of its gross monthly income. We also calculate a buyer’s monthly mortgage payment for the median-priced home assuming a conventional 30-year fixed-rate mortgage and a 14% down payment — the median down payment in 2022 was 14%, according to the National Association of Realtors.1 Given this comprehensive measure of affordability, we observe family income, housing prices, mortgage rates, as well as loan, down payment, and principal and interest components.
A higher HAI indicates greater affordability. A ratio of 100 indicates that median family income is just sufficient to purchase the median-priced home. When the HAI falls below 100, the median family income is no longer enough to affordably finance the median priced home at prevailing interest rates. On the other hand, when the affordability index is greater than 100, it indicates that the typical household has more income than necessary to purchase the typical house.
Housing Affordability Conditions
Figure 1 illustrates the Housing Affordability Index for South Dakota and the United States dating back to July 2016. There are several trends that emerge immediately. First and foremost, single-family housing was more affordable in South Dakota, relative to the US, over the period of interest. Secondly, while affordability conditions have deteriorated recently, single-family homes in South Dakota remained affordable according to the “golden rule of lending” — a period low of 100.2 was recorded in March 2023 before rebounding to 108.3 one month later. At the same time, the HAI for the US fell to a low of 91.3 in March 2023 before rebounding to 95.6 in April. Affordability conditions peaked in both South Dakota and the US at the end of 2020 through the first half of 2021, with HAI values of 200.3 and 149.3, respectively.
Figure 2 places South Dakota housing affordability into context with neighboring Midwest states, including Iowa, Minnesota, Nebraska, and North Dakota. Overall, South Dakota and its Midwest neighbors follow a similar trend over time. Affordability conditions begin to deteriorate at the end of 2016 and continued declining through late 2018. Trends reverse immediately at the beginning of 2019 and continue until they reach record peaks throughout 2021. Iowa and North Dakota maintained similar HAI values from 2016 through 2023 and were the most affordable states according to the HAI where they scored 240.0 and 238.6, respectively, in August 2021. Within the last year, affordability conditions have declined slightly, leveled off, and are beginning to surge upward as of April 2023. It is also noteworthy that South Dakota and its neighboring Midwest states have retained HAI values well above the US average since July 2016.
The standard HAI assumes a down payment of 14%, the median down payment in the US during 2022; however, this value is likely to differ along several demographic and economic characteristics. For example, it could be that first-time homebuyers, individuals with less education, and lower incomes are likely to put less towards the down payment of a home than experienced homebuyers, individuals with more education, and higher incomes. Figure 3 illustrates varying South Dakota HAI values based on different down payment percentages. According to the National Association of Realtors, the typical down payment for first-time homebuyers was 6% in 2022. This is reported in the most conservative HAI series in Figure 3, while the intermediate series reflects our standard 14% down payment as reported in 2022, and the more aggressive HAI series reflects a down payment amount of 20%, the proportion required to avoid private mortgage insurance.
While Figure 3 illustrates the same series at varying proportions, it is important to acknowledge the unique levels. Specifically, individuals making a much smaller down payment are going to face significantly more challenging affordability conditions than a homebuyer making a 14% or 20% down payment. For example, homebuyers falling into the 6% down payment category have faced what lenders would consider high-risk home buying conditions (HAI<100) since October 2022, while those in the 14% and 20% categories have not had these concerns throughout the period of interest. In contrast, buyers with an expected downpayment of 20% reached lowest affordability conditions of 7.7% (HAI=107.7) above qualifying income amounts while maximums reached amounts 115.3% (HAI=215.3) above qualifying income. It is important to acknowledge the difference that a large down payment can make in the housing affordability discussion.
The Components of Housing Affordability
While investigating housing affordability conditions as the composite of several important housing market factors provides the most comprehensive picture, it is also a useful exercise to breakdown the components contributing to the HAI dynamics. In the following, we investigate housing prices, family incomes, as well as the role mortgage rates play in monthly principal and interest payments.
Figure 4 illustrates housing prices for South Dakota and neighboring Midwest states and the US in constant 2022 dollars. As expected, median listing prices across the Midwest states were lower than at the national level. The median price for the US was $419,019 in April 2023, an increase of 2.7% from a year earlier. Of the Midwest states considered, Minnesota had the highest listing prices at $371,900 in April 2023, an increase of only 0.6% from a year earlier. Whereas, while South Dakota has not seen as extreme growth as Nebraska or Iowa in the last year, South Dakota’s listing prices are the second highest at $353,025 in the states considered and has undergone the largest growth of any of the states in the last two years (25.2% increase from April 2021 to April 2023).
Figure 5 illustrates median-monthly family income using inflation-adjusted 2022 dollars. As described above, an increase in family income increases housing affordability. While the overall trend in Figure 5 shows that real family incomes have largely increased within the period of interest, Minnesota and North Dakota are well above the national figure, with real monthly family incomes of $8,816 and $9,140, respectively. Examining growth rates, this pattern remains. From April 2022 to April 2023, Minnesota and North Dakota are the only states of interest with growth in real family incomes above the US figure with rates of 4.2% and 8.0%, respectively, while South Dakota’s growth of 2.3% over the same period is just slightly higher than Nebraska and Iowa. It is clear that slow growth in family incomes has continued to place stress on housing affordability across several of these states.
Mortgage Rates & Principal and Interest Payments
Mortgage interest rates and principal and interest payments directly influence housing affordability by adjusting the necessary qualifying income amounts. Figure 6 illustrates the evolution of the average 30-year fixed-rate mortgage across the US. From April 2022 to April 2023, average mortgage rates increased 27.3% across the US. The sharp increases in mortgage rates shown in Figure 6 and the similarly rapid rise in home prices shown in Figure 4 are the two primary causes of reduced housing affordability we’ve experienced in recent years. Figure 7 illustrates how changing home prices and mortgage rates impact monthly principal and interest payments. From April 2021 to April 2023 the monthly principal and interest payment for the median-priced home South Dakota increased by $858 ($1,030 to $1,888). At the national level, the monthly principal and interest payment for the median-priced home rose by $826 ($1,415 to $2,241) during the same period.
Housing affordability is influenced by a range of factors, including home prices, incomes, and mortgage rates. Each of these components offers valuable insights into the housing market, but to gain a comprehensive understanding, it is pivotal to consider them within the dynamic framework of an affordability index. It is likely that in the immediate future, changes in interest rates will have the greatest impact on affordability, while in the longer term, we can anticipate prices to adjust in response to shifts in housing demand. Recognizing and comprehending these factors will be vital in effectively addressing the challenges associated with housing affordability.