Home Affordability 'Is the Worst It's Ever Been,' According to Analysts. What Should You Do?

Home buyers are facing the worst affordability conditions, and it may get worse.

The typical home value in the United States is $331,533, a 20.3% increase in just one year. This increase equates to just over $67,000 from 2021 to 2022, which is a record high. According to a BofA Global Research note by BofA Securities U.S. Economist Alexander Lin and BofA Securities U.S. and Global Economist Jeseo Park, "Affordability from a home price/down payment perspective is the worst it's ever been, meaning extreme barriers to entry."

“Given these extraordinary supply challenges, we expect home prices to stay hot at a 10% [year-over-year] clip in 2022 despite existing home sales pulling back.” Both supply chain issues and booming demand has contributed to home buyers facing major affordability issues.

Limited home inventory

Low interest rates, surging demand, and dwindling supply have led to the surge in home prices. The National Association of Realtors estimates that nearly 1 million renter households have been priced out of the housing market. As a result, the share of first-time home buyers has fallen to 26%, an eight-year low.

On top of that, the number of entry-level homes -- properties sized 1,400 square feet or less -- is at a five-decade low. Starter homes accounted for 40% of new construction in 1980. In 2020, they accounted for only 7% of new construction. Low supply of available and new homes coupled with high demand continues to drive prices. As a result, home affordability has become a substantial issue.

The pandemic, supply chain issues, and now the crisis in Ukraine has exacerbated home inventory by extending build timelines. It has also further increased material prices needed to build new homes.

Housing affordability continues to decline

The National Association of Realtors’ (NAR) Housing Affordability Index measures whether a typical family could qualify for a mortgage loan on a typical home. According to the most recent monthly index, the affordability index dropped from 143.1 in January to 135.4 in February, a decrease of 5%.

Compared to one year ago, the monthly mortgage payment for a typical home increased by about 30%, while median family income rose by just 3.6%. According to the NAR report, “A home purchase was unaffordable for a typical first-time buyer intending to purchase a typical home. First-time buyers typically spent 25.6% of their family income on mortgage payments, making a home purchase unaffordable.” A mortgage is considered affordable if the mortgage payment, which includes the principal and interest, is less than 25% of the family’s income.

Should you buy or rent?

Despite the increase in mortgage rates, the housing market is expected to remain competitive. Down payments are often the biggest hurdle for first-time home buyers. According to a Zillow report, down payments increased by more than $10,000 in 2021 for a typical 30-year fixed mortgage. The decision to buy a home should be based on your personal financial situation.

The average homeowner will pay an additional $15,405 each year on top of their mortgage. These additional costs include utilities, home improvements, maintenance, property taxes, and homeowners insurance. Before taking the leap to buy a home, you should take into account all the expenses of home ownership.

Even with home values surging, it's important not to rush into purchasing a home you can’t afford, and potential buyers should avoid overpaying for a house. According to Lin and Park, it is better to buy than rent, but only if you can afford the “historically high down payment.”