Monthly House Payments, Rents, and Incomes

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Last week we compared San Diego rents and incomes to home prices. Let's now do the same for monthly payments on those homes.

The following charts compare San Diego incomes and rents with the monthly payment on a typical single family home. Non-nerds, avert your gaze from the rest of this paragraph as it goes into the minutiae of how the graphs were constructed. The home price is figured using the Case-Shiller price index rebased to the December 2007 median single family home price. The mortgage payment is calculated based on the average Freddie Mac 30-year fixed rate mortgage with a 20 percent down payment. I've also added in property tax at 1.1 percent (thanks to reader Tom for the suggestion).

Given that mortgage rates continue to be quite low by historical standards, it should be no surprise that homes look quite a bit more reasonably priced when you compare rents and incomes to monthly payments instead of home prices. While the price-to-income and price-to-rent ratio would have to respectively fall by 25 and 24 percent to reach the levels seen at the trough of the 1990s housing bust, the payment-to-income ratio would have to fall 19 percent and the payment-to-rent ratio by just 18 percent to hit their mid-1990s low points.

And the payment-to-income and payment-to-rent ratios are quite a bit closer to the bottoms of their pre-bubble ranges than to the tops -- a characteristic not shared by the price-to-income and price-to-rent ratios. The accompanying charts make monthly payments look downright reasonable on a historical basis.

But taken in isolation, monthly payments aren't the right metric to use in order to judge home valuations.

It is pretty clear that for most of the history displayed on the charts, the payment-to-income and payment-to-rent ratios hewed pretty closely to mortgage rates themselves. Typically, the monthly payment ratios would move up when rates were moving up and down when rates were moving down. It wasn't until the recent housing bubble, when the payment ratios shot up while rates dropped and then languished at generational lows, that this relationship broke down.

But the recent bubble is an abberation in which home prices rose not due to low rates but to an extended period of incredibly reckless mortgage lending. Looking back beyond this risky-lending-induced bubble, there just isn't much historical data to suggest that homes should necessarily be more expensive when mortgage rates are low and less expensive when rates are high.

The point can be further illustrated by comparing the recent bubble peak to the early 1980s, when double-digit mortgage rates prevailed. If monthly payments are a good valuation metric, then these charts suggest that the overvaluation of the recent bubble was not nearly as large as that seen in the early 1980s. This is ridiculous, of course. The recently burst bubble absolutely blew away prior booms in terms of magnitude, as a quick glance at the bubble aftermath depicted in this long-term foreclosure graph easily demonstrates.

While payments aren't a good valuation metric by themselves, however, they do have an influence. Monthly payments are a crucial element of the rent-or-buy calculation and will thus affect the level of demand coming from renters or investors jumping into the market. This phenomenon can perhaps be seen in the fairly consistent payment-to-rent "floor" in the second chart above.

All told, it's certainly worth keeping an eye on how monthly house payments compare to rents and incomes. But we'll keep an eye on everything else, too.

-- RICH TOSCANO