Following a meeting of the Federal Open Market Committee (FOMC) last week, the short-term Federal Funds rate will remain unchanged. This should prove a boon for shorter-term debt such as car loans and or adjustable-rate mortgages (ARMs). But with more than half of U.S. households having 30-year fixed-rate mortgages, what does this mean for first-time home buyers?
First American’s chief economist, Mark Fleming, suggests that the future looks bright for first-time home buyers. Since short-term rate changes by nature don’t impact long-term fixed-rate mortgages, Fleming argues in a new blog post that the most important question to consider is what mortgage principal and interest payment most renters could feasibly borrow in order to secure their first home, and how this is affected by mortgage rates.
While some experts use the median household income of all households to approach that question, Fleming points out that most homeowner households have a considerably higher income than the average renter household, which skews the median. In fact, based on 2016 Census data, the income gap between homeowner households ($70,000) and renter households ($37,000) is $33,000. As such, using the median household income for all households presents an inaccurate view of the actual borrowing power of a typical renter household.
Assuming a renter can spend one-third of their income on a mortgage, that works out to $12,333 for an annual income of $37,000. With the current mortgage rate of approximately 4 percent, that hypothetical renter should be able to borrow around $213,000. During 2012’s 30-year rate lows, that same renter could have borrowed around $242,000.
While President Trump recently nominated Jerome Powell to succeed current Fed Chair Janet Yellen, Fleming points out that Powell is “widely believed to hold a similar stance on monetary policy as [Yellen].” With most economists forecasting a rate hike to 5 percent for 30-year fixed-rate mortgages in 2018, a renter earning $37,000 a year could still feasibly borrow $190,000 for their first home.
“While borrowing power for the potential home buyer has fallen relative to the low point of 2012, it remains high today and will remain high next year, relative to the long run average,” said Fleming. “If you don’t want to rent anymore and are considering becoming a homeowner, even if mortgage rates rise next year, your borrowing power will remain strong by historic standards.”