The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
Federal Reserve Bank of Cleveland T.able 2 Fixed-Rate, Level-Payment Mortgages at Various Interest Rat8$ Principal: $50,000 Term: 30 Years R..-, percent 8 10 12 14 16 18 20 Monthly payment (principal and interest), a dollars Total intenllt b payment, dollan 82.080 107,966 135,150 163,280 192,060 221,275 250,785 366.88 438.79 514.31 592.44 672.38 763.54 835.61 .~ IntenIIt of total To~ paid, doIlan 62 88 73 77 79 82 83 132.oso 157,965 185.150 213,280 242,060 271,275 300.785 a. Excludes proparty taxes and insurance premiums. b. Assumes mortgage is held to maturity. their housing because of tax considerations. During inflationary periods, nominal incomes tend to rise, pushing individuals into higher tax brackets. The progressive nature of the U.S. tax system and the fact that interest deductions are concentrated in the early years of a mortgage may provide an incentive to sell and assume a new mortgage to maximize the tax-sheltering feature of housing. This is particularly true for individuals who have experienced substantial income growth, resultinq in a significant decline in the portion of income allocated to housing expenditures. The differential impact of housing price inflation also is evidenced by changes in the composition of participants in the home buying market. In one study of homes financed by savings and loans, first-time buyers accounted for 36 percent of all home buyers in 1977, but this percentage declined to 17 percent in 1979.8 While repurchasers generally "trade up" to larger homes, first-time buyers are concentrated at the lower-priced end of the market. In 1977, the median purchase price paid by first-time 8. See "Homeownership: Coping United States Savings League. with Inflation," buyers was $37,000, compared with $48,472 for repurchasers; in 1979, first-time buyers paid a median price of $48,950, compared with $60,600 for repurchasers. Although rising housing prices have a differential impact at the down-payment stage, this is not necessarily the case in financing the balance of the purchase price unless the repurchaser applies a large portion of his accumulated equity to the down payment, thereby reducing the amount financed by a mortgage loan. As mortgage interest rates rise, the proportion of the total payment devoted to interest over the life of the loan also rises (see table 2). To assess the impact of rising housing prices and interest rates on housing sales, the proportion of income devoted to housing may be considered on a yearly basis, using that year's median sales price of a new home, median household income, average effective mortgage interest rate, average down payment, and average loan maturity. By using the loan terms in effect for a specific year, it can be seen that the monthly payment burden has increased faster than income. Today's home buyer must allocate a substantially larger portion of current income to housing expenditures than was the case five years ago. In 1979, the median-income family purchasing a median-priced home allocated 27.1 percent of annual income to housing expenditures, compared with 16.4 percent in 1970 (see table 1). Moreover, these figures do not take into account the corresponding increases in property taxes, insurance premiums, and maintenance costs. On the other hand, the tax advantages of home ownership also have been excluded, although, as noted earlier, these may be a significant factor in the decision to purchase a home. Conclusion In summary, home ownership costs have increased substantially in the past three years, both as a result of inflation and the increase in real mortgage interest rates. Although innovative financing techniques and the increase in two-wage-earner families have overcome the barriers to home ownership to some extent, they are unlikely to put housing within the reach of many potential firsttime buyers. Single-family housing proved to be an excellent investment in the 1970s, when low real interest rates and accelerating inflation increased the demand for singlefamily housing. In the past three years, however, regulatory changes have integrated the mortgage markets with the capital markets, increasing the volatility and cost of mortgage credit. With the growing importance of variable-rate mortgage loans, home buyers also will face greater uncertainty with respect to their monthly housing expenditures. At the same time, government incentives to encourage investment in the nation's industrial sector are likely to reduce the attractiveness of housing as an investment. Given these factors, the climb of housing prices will likely be restrained in the 1980s. NOTE: No issues of the Economic Commentary were published in October. Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address correction requested o Correct as shown o Remove from mailing BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 Economic Commentary ISSN 0428·1276 Current Perspectiveson Home Ownership by Judy Z, Menich Between 1970 and 1979, the median sales price of an existing single-family home rose roughly 170 percent, while the general price level increased 113 percent. The number of housing units also increased substantially: 17.8 million housing units were produced during the 1970s, or 24 percent more than in the previous decade.1 As the 1970s advanced, the role of housing shifted from primarily a consumption item to an investment item, a role that was further enhanced by declines in real after-tax returns on such financial assets as stocks, bonds, and savings accounts. Since late 1979, housing prices, adjusted for inflation, actually have decl ined. Moreover, the trend toward larger homes has reversed: the average size of a new house, which peaked in 1978 at 1650 square feet, has been decreasing since. Today's new list Please send mailing label to the Research Department, Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH 44101. November 2,1981 1. See "Housing: Sacred Cow," FRB SF Weekly Letter, Federal Reserve Ban k of San Francisco, November 28,1980. home buyers are faced with paying more money for less living space, although the price per square foot has declined somewhat since 1979. This Economic Commentary examines the underlying causes of the rapid escalation and subsequent deceleration in home prices, focusing on the economic developments that were the major stimulus to home ownership in the 1970s. Inflation and Housing Prices Historically, an increase in the general price level has been accompanied by a proportionate increase in housing prices; from 1950 until the mid-1960s, housing prices advanced at roughly the same rate as the overall inflation rate. During this same period, median family income grew at a Judy Menich is an economic analyst with the Federal ReserveBank of Cleveland. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal ReserveSystem. faster rate 1970s, than overall however, prices. housing at a substantially faster of other Between goods. existing home annual they 1971 prices increased increased and (14.4 gain percent), between percent 1976 and 12 percent between but 1975, at an average annually.2 Existing home prices experienced year-to-year their largest 1978 increased and 1979 by only 11.7 from 1979 to 1980. The slowdown the appreciation of home an increase of 6.8 percent markets illustrates interest The demand hold the impact including formations, in housing of escalating rates on housing for housing factors, with in the 12 months ending in June 1981. The softening mortgage in is influenced income by house- changes, and the desire ration to hedge against inflation. The rnatuof the postwar "baby boom" has pro- vided some family housing, thereby 3 prices. Although rising form the trends In particular, and growing marriage numbers In 1979, new 22.4 recent to the de- the rising divorce to postpone contributed percent rate or forego to growing of all home with 1977. At the same time, of unmarried Economic stimulus couples have to home ownership, homes. been the particu- 1978. returns assets, strong incentive the tax advantages rates so goods. lowered that money-market institutions to compete deposits, thereby of financial also funds. was of their without a parallel of their assets (i.e., mortgage quentlv, tend lenders long-term reduction home from their nitely the expense with for many for risk the maturity was shortened loans). Conse- The households after-tax duced, because from taxable burden was incorporated rate.4 In fact, mortgage in December interest 1980, to home the after-tax costs of owners and income the capital-gains hedge. accrue Home payments below and 1978, making inviting inflation decrease com1977. rates averaged advantages taxable rate stood in December 1975 the can deduct property taxes and defer indefi- taxes on any profit 2. Moreover, these figures do not take into account the impact of concessionary financing schemes, which are tantamount to lowering prices. received from the sale of their homes. deferral assumes 3. The 25-34 age group, the prime homebuying ages, increased by 22 percent between 1970 and 1975 and by 17 percent between 1975 and 1980, compared with overall population increases of 4.4 percent and 4.2 percent, respectively. 4. The real mortgage rate is calculated by subtracting the annual rate of inflation as measured by the implicit price deflator for personal consumption expenditures from the mortgage rate. that the seller (This purchases home of investment the major investment family mate pace tax ownership in other at assets, represents as well as shelter. cost of housing income growth payment nominal rental housing property. from that the lating ordinary During proportional to deductible. to owners keeps approxi- duced by rate. Because allowances for income tends to rise rise over time the financial is shifted bur- to the early Yet, at the same time, interest ing the early years of a mortgage distorting is the disparate Thus, ance the the realized 5. At the present time, 60 percent of long-term capital gains are excluded from taxation. For an individual in the 50 percent bracket, the maximum long-term capital gains tax rate is 20 percent (40 percent of the 50 percent tax bracket). However, a large capital gain can trigger the alternative minimum tax, which is paid on a portion of the 60 percent of gains excluded from taxation. 6. In recent months, a wide variety of financing arrangements have surfaced in the housing markets, including variable rate, shared appreciation, reverse annuity, and rollover mortgages. Although these forms of "creative financing" may become more important in the future, until recently the majority of home purchases were financed by mortgage loans with fixed interest rates and 20-year to 30-year terms to maturity. from and prop- level, of rental property because depreciation property and, that are re- are based therefore, the general do not accelerates, of rental In addition, housing capital the sale of rental regains housing are while such gains can be deferred in the case of owner- puted taxable bility lowers housing home housing. rental The exclusion income income of interest the of home despite user cost vis-a-vis rental owners thereby the of tax deducti- lax expenses housing the from owner-occupied with a distinct affecting of the im- owners and property and provides tax advantage, choice of owning versus renting. are homes sinqle-farnilv has been viewed as an effective of "coping with inflation," 16,009 17.640 19.680 21,398b 22,977b 16.3 : 16.2 19.3 21.2 , 2.9 3.0 3.0 3.2 3.2 21.9 3.3 3.3 29.5 31.0 : ...... 22.5 23.2 24.6 27.1 .S; -: 7) of Commerce and Board of Governors of the Federal Reserve System. escalating interest less attractive costs continue home prices means such investments as real home to spiral. and rates have excluded home buyers First-time buyers Rapidly median potential from 1975 3.06. During (see table in particular mortgage tion's fluctuating rates, which home 60 percent, Although to benefit present prudently can the acquire. difficulty homes a High interest have eroded shows that with the liquidity growth income the rates in selling of was increased by family in- in home upgrade the buyer, owners. a new may have an additional are they a can Appreciation repurchasers by applying in a previous on prices has enabled their housing accumulated payment fi rst-time home values housing to the equity home to a down home.1 Repurchasers incentive to upgrade owners. of the historical income the household encountered in housing for current between pace and reduce 2.58; ratio the median while median steep barrier debt the come grew by only 43 percent. to the payment this sales price of an existing add uncertainty mortgage of averaged 1979, period, cost of funds, of ratio latter roughly the institu- mortgage kept Mortgage the income through to a financial monthly prices financing. it terms decade, family are linked amount ship 1). are finding and to secure with past sales price of a new home to annual mortgage to meet down-payment instruments the median high more difficult generally Over many from the market An examination in 16A 2.4 2.5 2.5 2.7 2.8 13,719 14,958 64,500 68,800 U.S. Department becoming ownership investment Costs investment 9,867 10,285 11,116 12,051 12,902 44,200 48,800 55,700 62,900 SOURCES: existing Although 39,300 family income-:., to Income a. Monthly payment includes principal and interest only and assumes average loan terms for year listed-Le .• average effective loan rate on conventional mortgage, average term to maturity, •••• average down payment-on loan to purchase newly built home. b. Figures are estimated. and Home Ownership 1975 1976 1977 1978 1979 Ratio of sales price allow- more likely to be taxed, occupied 23,400 25,200 27,600 32,500 35,900 L Monthly payment~ espercent of median' price level. of the depreciation indefinitely 1970 1971 1972 1973 1974 1980 1981 (6 monthsl are fully advantages attractiveness dur- treat- tax as inflation as an investment. in the price with diminishes ducing the rental value gains. at a rate roughly Any costs pav- loan. element historical capital interest increase inflation, on trans- years, these gains are even though which the to the year into the ownership erty taxes, tax income of thereby _homes. dollars V_ investment by shifting is sold, the from owner favors ownership property On Median family income. dollars Median •••• price of are income housing home taxes '" Table 1 Home Prices and Family Income: 1970-81 nominal to the Inflation in owner-occupied returns owned income. rental is taxable accrue share of the mortgage of housing hand, provided of tax-deductible An additional property is fixed over the life periods, years of the mortgage. a disproportionate even though other the from is not taxed, not taxable also is re- payment, the inflation of the loan, and because ment consists within financing costs are deducted income.6 Inflation reduces the with the mortgage taxation gains federal a home of a mortgage that stock Because has encouraged of the six- flow capital additional period. den of home ownership ownership. interest time during inflationary housing an especially all may purchase policy financial long-term of equities, from the sale of stock, even though a short a any unless between that they on owners as corporate to ex- pared with 3.03 percent owners such mortgages interest tax assets, less willing percent Several By comparison, other received in the maturity risk premium Real mortgage taxes.5 are taxed interest paying any capital- gains became real (inflation-adjusted) 5.88 gains without fixed-rate in the mortgage at taxable the exposure since income from a stable deposits and rental housing. rental deductible to interest-rate increased, structure imputed and more effectively institutions ment of owner-occupied The costs inexpensive. However, home a seller borrowing mortgage maintaining expensive In addition, in capital to en- rate, enabled or more, months.) aged 55 or over can realize up to $125,000 a housing certificate, interest 24 with from 1974-77,making in mid-1978 equally, within of home owner- relatively another vis-a-vis In addition inflation-adjusted The introduction near-market more real mortgage declined home ownership month housing to purchase hancing rates actually in- housing households to other ship, inflation Accelerating on providing relative in numbers to with the tax laws, distorted after-tax other 3 percent buyers 17.0 percent increasing are purchasing developments the 1975 together a substantial households of singles in the overall population. were single, compared major to demand, are adding tendency have for single- contributing basis of housing socioeconomic mand. demand from of mortgage demand. population, underlying larly flation, values since mid- 1980 has been even more pronounced, many the increased rate than the prices rate of 9 percent; 1980, During prices and changes rise in housing relationhousing have not prices. 7. In 1979 the typical repurchaser applied only one-third of the equity realized from the sale of a previous residence to the new purchase. See "Homeownership: Coping with Inflation," United States Savings League: Chicago, Illinois, 1980. faster rate 1970s, than overall however, prices. housing at a substantially faster of other Between goods. existing home annual they 1971 prices increased increased and (14.4 gain percent), between percent 1976 and 12 percent between but 1975, at an average annually.2 Existing home prices experienced year-to-year their largest 1978 increased and 1979 by only 11.7 from 1979 to 1980. The slowdown the appreciation of home an increase of 6.8 percent markets illustrates interest The demand hold the impact including formations, in housing of escalating rates on housing for housing factors, with in the 12 months ending in June 1981. The softening mortgage in is influenced income by house- changes, and the desire ration to hedge against inflation. The rnatuof the postwar "baby boom" has pro- vided some family housing, thereby 3 prices. Although rising form the trends In particular, and growing marriage numbers In 1979, new 22.4 recent to the de- the rising divorce to postpone contributed percent rate or forego to growing of all home with 1977. At the same time, of unmarried Economic stimulus couples have to home ownership, homes. been the particu- 1978. returns assets, strong incentive the tax advantages rates so goods. lowered that money-market institutions to compete deposits, thereby of financial also funds. was of their without a parallel of their assets (i.e., mortgage quentlv, tend lenders long-term reduction home from their nitely the expense with for many for risk the maturity was shortened loans). Conse- The households after-tax duced, because from taxable burden was incorporated rate.4 In fact, mortgage in December interest 1980, to home the after-tax costs of owners and income the capital-gains hedge. accrue Home payments below and 1978, making inviting inflation decrease com1977. rates averaged advantages taxable rate stood in December 1975 the can deduct property taxes and defer indefi- taxes on any profit 2. Moreover, these figures do not take into account the impact of concessionary financing schemes, which are tantamount to lowering prices. received from the sale of their homes. deferral assumes 3. The 25-34 age group, the prime homebuying ages, increased by 22 percent between 1970 and 1975 and by 17 percent between 1975 and 1980, compared with overall population increases of 4.4 percent and 4.2 percent, respectively. 4. The real mortgage rate is calculated by subtracting the annual rate of inflation as measured by the implicit price deflator for personal consumption expenditures from the mortgage rate. that the seller (This purchases home of investment the major investment family mate pace tax ownership in other at assets, represents as well as shelter. cost of housing income growth payment nominal rental housing property. from that the lating ordinary During proportional to deductible. to owners keeps approxi- duced by rate. Because allowances for income tends to rise rise over time the financial is shifted bur- to the early Yet, at the same time, interest ing the early years of a mortgage distorting is the disparate Thus, ance the the realized 5. At the present time, 60 percent of long-term capital gains are excluded from taxation. For an individual in the 50 percent bracket, the maximum long-term capital gains tax rate is 20 percent (40 percent of the 50 percent tax bracket). However, a large capital gain can trigger the alternative minimum tax, which is paid on a portion of the 60 percent of gains excluded from taxation. 6. In recent months, a wide variety of financing arrangements have surfaced in the housing markets, including variable rate, shared appreciation, reverse annuity, and rollover mortgages. Although these forms of "creative financing" may become more important in the future, until recently the majority of home purchases were financed by mortgage loans with fixed interest rates and 20-year to 30-year terms to maturity. from and prop- level, of rental property because depreciation property and, that are re- are based therefore, the general do not accelerates, of rental In addition, housing capital the sale of rental regains housing are while such gains can be deferred in the case of owner- puted taxable bility lowers housing home housing. rental The exclusion income income of interest the of home despite user cost vis-a-vis rental owners thereby the of tax deducti- lax expenses housing the from owner-occupied with a distinct affecting of the im- owners and property and provides tax advantage, choice of owning versus renting. are homes sinqle-farnilv has been viewed as an effective of "coping with inflation," 16,009 17.640 19.680 21,398b 22,977b 16.3 : 16.2 19.3 21.2 , 2.9 3.0 3.0 3.2 3.2 21.9 3.3 3.3 29.5 31.0 : ...... 22.5 23.2 24.6 27.1 .S; -: 7) of Commerce and Board of Governors of the Federal Reserve System. escalating interest less attractive costs continue home prices means such investments as real home to spiral. and rates have excluded home buyers First-time buyers Rapidly median potential from 1975 3.06. During (see table in particular mortgage tion's fluctuating rates, which home 60 percent, Although to benefit present prudently can the acquire. difficulty homes a High interest have eroded shows that with the liquidity growth income the rates in selling of was increased by family in- in home upgrade the buyer, owners. a new may have an additional are they a can Appreciation repurchasers by applying in a previous on prices has enabled their housing accumulated payment fi rst-time home values housing to the equity home to a down home.1 Repurchasers incentive to upgrade owners. of the historical income the household encountered in housing for current between pace and reduce 2.58; ratio the median while median steep barrier debt the come grew by only 43 percent. to the payment this sales price of an existing add uncertainty mortgage of averaged 1979, period, cost of funds, of ratio latter roughly the institu- mortgage kept Mortgage the income through to a financial monthly prices financing. it terms decade, family are linked amount ship 1). are finding and to secure with past sales price of a new home to annual mortgage to meet down-payment instruments the median high more difficult generally Over many from the market An examination in 16A 2.4 2.5 2.5 2.7 2.8 13,719 14,958 64,500 68,800 U.S. Department becoming ownership investment Costs investment 9,867 10,285 11,116 12,051 12,902 44,200 48,800 55,700 62,900 SOURCES: existing Although 39,300 family income-:., to Income a. Monthly payment includes principal and interest only and assumes average loan terms for year listed-Le .• average effective loan rate on conventional mortgage, average term to maturity, •••• average down payment-on loan to purchase newly built home. b. Figures are estimated. and Home Ownership 1975 1976 1977 1978 1979 Ratio of sales price allow- more likely to be taxed, occupied 23,400 25,200 27,600 32,500 35,900 L Monthly payment~ espercent of median' price level. of the depreciation indefinitely 1970 1971 1972 1973 1974 1980 1981 (6 monthsl are fully advantages attractiveness dur- treat- tax as inflation as an investment. in the price with diminishes ducing the rental value gains. at a rate roughly Any costs pav- loan. element historical capital interest increase inflation, on trans- years, these gains are even though which the to the year into the ownership erty taxes, tax income of thereby _homes. dollars V_ investment by shifting is sold, the from owner favors ownership property On Median family income. dollars Median •••• price of are income housing home taxes '" Table 1 Home Prices and Family Income: 1970-81 nominal to the Inflation in owner-occupied returns owned income. rental is taxable accrue share of the mortgage of housing hand, provided of tax-deductible An additional property is fixed over the life periods, years of the mortgage. a disproportionate even though other the from is not taxed, not taxable also is re- payment, the inflation of the loan, and because ment consists within financing costs are deducted income.6 Inflation reduces the with the mortgage taxation gains federal a home of a mortgage that stock Because has encouraged of the six- flow capital additional period. den of home ownership ownership. interest time during inflationary housing an especially all may purchase policy financial long-term of equities, from the sale of stock, even though a short a any unless between that they on owners as corporate to ex- pared with 3.03 percent owners such mortgages interest tax assets, less willing percent Several By comparison, other received in the maturity risk premium Real mortgage taxes.5 are taxed interest paying any capital- gains became real (inflation-adjusted) 5.88 gains without fixed-rate in the mortgage at taxable the exposure since income from a stable deposits and rental housing. rental deductible to interest-rate increased, structure imputed and more effectively institutions ment of owner-occupied The costs inexpensive. However, home a seller borrowing mortgage maintaining expensive In addition, in capital to en- rate, enabled or more, months.) aged 55 or over can realize up to $125,000 a housing certificate, interest 24 with from 1974-77,making in mid-1978 equally, within of home owner- relatively another vis-a-vis In addition inflation-adjusted The introduction near-market more real mortgage declined home ownership month housing to purchase hancing rates actually in- housing households to other ship, inflation Accelerating on providing relative in numbers to with the tax laws, distorted after-tax other 3 percent buyers 17.0 percent increasing are purchasing developments the 1975 together a substantial households of singles in the overall population. were single, compared major to demand, are adding tendency have for single- contributing basis of housing socioeconomic mand. demand from of mortgage demand. population, underlying larly flation, values since mid- 1980 has been even more pronounced, many the increased rate than the prices rate of 9 percent; 1980, During prices and changes rise in housing relationhousing have not prices. 7. In 1979 the typical repurchaser applied only one-third of the equity realized from the sale of a previous residence to the new purchase. See "Homeownership: Coping with Inflation," United States Savings League: Chicago, Illinois, 1980. faster rate 1970s, than overall however, prices. housing at a substantially faster of other Between goods. existing home annual they 1971 prices increased increased and (14.4 gain percent), between percent 1976 and 12 percent between but 1975, at an average annually.2 Existing home prices experienced year-to-year their largest 1978 increased and 1979 by only 11.7 from 1979 to 1980. The slowdown the appreciation of home an increase of 6.8 percent markets illustrates interest The demand hold the impact including formations, in housing of escalating rates on housing for housing factors, with in the 12 months ending in June 1981. The softening mortgage in is influenced income by house- changes, and the desire ration to hedge against inflation. The rnatuof the postwar "baby boom" has pro- vided some family housing, thereby 3 prices. Although rising form the trends In particular, and growing marriage numbers In 1979, new 22.4 recent to the de- the rising divorce to postpone contributed percent rate or forego to growing of all home with 1977. At the same time, of unmarried Economic stimulus couples have to home ownership, homes. been the particu- 1978. returns assets, strong incentive the tax advantages rates so goods. lowered that money-market institutions to compete deposits, thereby of financial also funds. was of their without a parallel of their assets (i.e., mortgage quentlv, tend lenders long-term reduction home from their nitely the expense with for many for risk the maturity was shortened loans). Conse- The households after-tax duced, because from taxable burden was incorporated rate.4 In fact, mortgage in December interest 1980, to home the after-tax costs of owners and income the capital-gains hedge. accrue Home payments below and 1978, making inviting inflation decrease com1977. rates averaged advantages taxable rate stood in December 1975 the can deduct property taxes and defer indefi- taxes on any profit 2. Moreover, these figures do not take into account the impact of concessionary financing schemes, which are tantamount to lowering prices. received from the sale of their homes. deferral assumes 3. The 25-34 age group, the prime homebuying ages, increased by 22 percent between 1970 and 1975 and by 17 percent between 1975 and 1980, compared with overall population increases of 4.4 percent and 4.2 percent, respectively. 4. The real mortgage rate is calculated by subtracting the annual rate of inflation as measured by the implicit price deflator for personal consumption expenditures from the mortgage rate. that the seller (This purchases home of investment the major investment family mate pace tax ownership in other at assets, represents as well as shelter. cost of housing income growth payment nominal rental housing property. from that the lating ordinary During proportional to deductible. to owners keeps approxi- duced by rate. Because allowances for income tends to rise rise over time the financial is shifted bur- to the early Yet, at the same time, interest ing the early years of a mortgage distorting is the disparate Thus, ance the the realized 5. At the present time, 60 percent of long-term capital gains are excluded from taxation. For an individual in the 50 percent bracket, the maximum long-term capital gains tax rate is 20 percent (40 percent of the 50 percent tax bracket). However, a large capital gain can trigger the alternative minimum tax, which is paid on a portion of the 60 percent of gains excluded from taxation. 6. In recent months, a wide variety of financing arrangements have surfaced in the housing markets, including variable rate, shared appreciation, reverse annuity, and rollover mortgages. Although these forms of "creative financing" may become more important in the future, until recently the majority of home purchases were financed by mortgage loans with fixed interest rates and 20-year to 30-year terms to maturity. from and prop- level, of rental property because depreciation property and, that are re- are based therefore, the general do not accelerates, of rental In addition, housing capital the sale of rental regains housing are while such gains can be deferred in the case of owner- puted taxable bility lowers housing home housing. rental The exclusion income income of interest the of home despite user cost vis-a-vis rental owners thereby the of tax deducti- lax expenses housing the from owner-occupied with a distinct affecting of the im- owners and property and provides tax advantage, choice of owning versus renting. are homes sinqle-farnilv has been viewed as an effective of "coping with inflation," 16,009 17.640 19.680 21,398b 22,977b 16.3 : 16.2 19.3 21.2 , 2.9 3.0 3.0 3.2 3.2 21.9 3.3 3.3 29.5 31.0 : ...... 22.5 23.2 24.6 27.1 .S; -: 7) of Commerce and Board of Governors of the Federal Reserve System. escalating interest less attractive costs continue home prices means such investments as real home to spiral. and rates have excluded home buyers First-time buyers Rapidly median potential from 1975 3.06. During (see table in particular mortgage tion's fluctuating rates, which home 60 percent, Although to benefit present prudently can the acquire. difficulty homes a High interest have eroded shows that with the liquidity growth income the rates in selling of was increased by family in- in home upgrade the buyer, owners. a new may have an additional are they a can Appreciation repurchasers by applying in a previous on prices has enabled their housing accumulated payment fi rst-time home values housing to the equity home to a down home.1 Repurchasers incentive to upgrade owners. of the historical income the household encountered in housing for current between pace and reduce 2.58; ratio the median while median steep barrier debt the come grew by only 43 percent. to the payment this sales price of an existing add uncertainty mortgage of averaged 1979, period, cost of funds, of ratio latter roughly the institu- mortgage kept Mortgage the income through to a financial monthly prices financing. it terms decade, family are linked amount ship 1). are finding and to secure with past sales price of a new home to annual mortgage to meet down-payment instruments the median high more difficult generally Over many from the market An examination in 16A 2.4 2.5 2.5 2.7 2.8 13,719 14,958 64,500 68,800 U.S. Department becoming ownership investment Costs investment 9,867 10,285 11,116 12,051 12,902 44,200 48,800 55,700 62,900 SOURCES: existing Although 39,300 family income-:., to Income a. Monthly payment includes principal and interest only and assumes average loan terms for year listed-Le .• average effective loan rate on conventional mortgage, average term to maturity, •••• average down payment-on loan to purchase newly built home. b. Figures are estimated. and Home Ownership 1975 1976 1977 1978 1979 Ratio of sales price allow- more likely to be taxed, occupied 23,400 25,200 27,600 32,500 35,900 L Monthly payment~ espercent of median' price level. of the depreciation indefinitely 1970 1971 1972 1973 1974 1980 1981 (6 monthsl are fully advantages attractiveness dur- treat- tax as inflation as an investment. in the price with diminishes ducing the rental value gains. at a rate roughly Any costs pav- loan. element historical capital interest increase inflation, on trans- years, these gains are even though which the to the year into the ownership erty taxes, tax income of thereby _homes. dollars V_ investment by shifting is sold, the from owner favors ownership property On Median family income. dollars Median •••• price of are income housing home taxes '" Table 1 Home Prices and Family Income: 1970-81 nominal to the Inflation in owner-occupied returns owned income. rental is taxable accrue share of the mortgage of housing hand, provided of tax-deductible An additional property is fixed over the life periods, years of the mortgage. a disproportionate even though other the from is not taxed, not taxable also is re- payment, the inflation of the loan, and because ment consists within financing costs are deducted income.6 Inflation reduces the with the mortgage taxation gains federal a home of a mortgage that stock Because has encouraged of the six- flow capital additional period. den of home ownership ownership. interest time during inflationary housing an especially all may purchase policy financial long-term of equities, from the sale of stock, even though a short a any unless between that they on owners as corporate to ex- pared with 3.03 percent owners such mortgages interest tax assets, less willing percent Several By comparison, other received in the maturity risk premium Real mortgage taxes.5 are taxed interest paying any capital- gains became real (inflation-adjusted) 5.88 gains without fixed-rate in the mortgage at taxable the exposure since income from a stable deposits and rental housing. rental deductible to interest-rate increased, structure imputed and more effectively institutions ment of owner-occupied The costs inexpensive. However, home a seller borrowing mortgage maintaining expensive In addition, in capital to en- rate, enabled or more, months.) aged 55 or over can realize up to $125,000 a housing certificate, interest 24 with from 1974-77,making in mid-1978 equally, within of home owner- relatively another vis-a-vis In addition inflation-adjusted The introduction near-market more real mortgage declined home ownership month housing to purchase hancing rates actually in- housing households to other ship, inflation Accelerating on providing relative in numbers to with the tax laws, distorted after-tax other 3 percent buyers 17.0 percent increasing are purchasing developments the 1975 together a substantial households of singles in the overall population. were single, compared major to demand, are adding tendency have for single- contributing basis of housing socioeconomic mand. demand from of mortgage demand. population, underlying larly flation, values since mid- 1980 has been even more pronounced, many the increased rate than the prices rate of 9 percent; 1980, During prices and changes rise in housing relationhousing have not prices. 7. In 1979 the typical repurchaser applied only one-third of the equity realized from the sale of a previous residence to the new purchase. See "Homeownership: Coping with Inflation," United States Savings League: Chicago, Illinois, 1980. Federal Reserve Bank of Cleveland T.able 2 Fixed-Rate, Level-Payment Mortgages at Various Interest Rat8$ Principal: $50,000 Term: 30 Years R..-, percent 8 10 12 14 16 18 20 Monthly payment (principal and interest), a dollars Total intenllt b payment, dollan 82.080 107,966 135,150 163,280 192,060 221,275 250,785 366.88 438.79 514.31 592.44 672.38 763.54 835.61 .~ IntenIIt of total To~ paid, doIlan 62 88 73 77 79 82 83 132.oso 157,965 185.150 213,280 242,060 271,275 300.785 a. Excludes proparty taxes and insurance premiums. b. Assumes mortgage is held to maturity. their housing because of tax considerations. During inflationary periods, nominal incomes tend to rise, pushing individuals into higher tax brackets. The progressive nature of the U.S. tax system and the fact that interest deductions are concentrated in the early years of a mortgage may provide an incentive to sell and assume a new mortgage to maximize the tax-sheltering feature of housing. This is particularly true for individuals who have experienced substantial income growth, resultinq in a significant decline in the portion of income allocated to housing expenditures. The differential impact of housing price inflation also is evidenced by changes in the composition of participants in the home buying market. In one study of homes financed by savings and loans, first-time buyers accounted for 36 percent of all home buyers in 1977, but this percentage declined to 17 percent in 1979.8 While repurchasers generally "trade up" to larger homes, first-time buyers are concentrated at the lower-priced end of the market. In 1977, the median purchase price paid by first-time 8. See "Homeownership: Coping United States Savings League. with Inflation," buyers was $37,000, compared with $48,472 for repurchasers; in 1979, first-time buyers paid a median price of $48,950, compared with $60,600 for repurchasers. Although rising housing prices have a differential impact at the down-payment stage, this is not necessarily the case in financing the balance of the purchase price unless the repurchaser applies a large portion of his accumulated equity to the down payment, thereby reducing the amount financed by a mortgage loan. As mortgage interest rates rise, the proportion of the total payment devoted to interest over the life of the loan also rises (see table 2). To assess the impact of rising housing prices and interest rates on housing sales, the proportion of income devoted to housing may be considered on a yearly basis, using that year's median sales price of a new home, median household income, average effective mortgage interest rate, average down payment, and average loan maturity. By using the loan terms in effect for a specific year, it can be seen that the monthly payment burden has increased faster than income. Today's home buyer must allocate a substantially larger portion of current income to housing expenditures than was the case five years ago. In 1979, the median-income family purchasing a median-priced home allocated 27.1 percent of annual income to housing expenditures, compared with 16.4 percent in 1970 (see table 1). Moreover, these figures do not take into account the corresponding increases in property taxes, insurance premiums, and maintenance costs. On the other hand, the tax advantages of home ownership also have been excluded, although, as noted earlier, these may be a significant factor in the decision to purchase a home. Conclusion In summary, home ownership costs have increased substantially in the past three years, both as a result of inflation and the increase in real mortgage interest rates. Although innovative financing techniques and the increase in two-wage-earner families have overcome the barriers to home ownership to some extent, they are unlikely to put housing within the reach of many potential firsttime buyers. Single-family housing proved to be an excellent investment in the 1970s, when low real interest rates and accelerating inflation increased the demand for singlefamily housing. In the past three years, however, regulatory changes have integrated the mortgage markets with the capital markets, increasing the volatility and cost of mortgage credit. With the growing importance of variable-rate mortgage loans, home buyers also will face greater uncertainty with respect to their monthly housing expenditures. At the same time, government incentives to encourage investment in the nation's industrial sector are likely to reduce the attractiveness of housing as an investment. Given these factors, the climb of housing prices will likely be restrained in the 1980s. NOTE: No issues of the Economic Commentary were published in October. Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address correction requested o Correct as shown o Remove from mailing BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 Economic Commentary ISSN 0428·1276 Current Perspectiveson Home Ownership by Judy Z, Menich Between 1970 and 1979, the median sales price of an existing single-family home rose roughly 170 percent, while the general price level increased 113 percent. The number of housing units also increased substantially: 17.8 million housing units were produced during the 1970s, or 24 percent more than in the previous decade.1 As the 1970s advanced, the role of housing shifted from primarily a consumption item to an investment item, a role that was further enhanced by declines in real after-tax returns on such financial assets as stocks, bonds, and savings accounts. Since late 1979, housing prices, adjusted for inflation, actually have decl ined. Moreover, the trend toward larger homes has reversed: the average size of a new house, which peaked in 1978 at 1650 square feet, has been decreasing since. Today's new list Please send mailing label to the Research Department, Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH 44101. November 2,1981 1. See "Housing: Sacred Cow," FRB SF Weekly Letter, Federal Reserve Ban k of San Francisco, November 28,1980. home buyers are faced with paying more money for less living space, although the price per square foot has declined somewhat since 1979. This Economic Commentary examines the underlying causes of the rapid escalation and subsequent deceleration in home prices, focusing on the economic developments that were the major stimulus to home ownership in the 1970s. Inflation and Housing Prices Historically, an increase in the general price level has been accompanied by a proportionate increase in housing prices; from 1950 until the mid-1960s, housing prices advanced at roughly the same rate as the overall inflation rate. During this same period, median family income grew at a Judy Menich is an economic analyst with the Federal ReserveBank of Cleveland. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal ReserveSystem. Federal Reserve Bank of Cleveland T.able 2 Fixed-Rate, Level-Payment Mortgages at Various Interest Rat8$ Principal: $50,000 Term: 30 Years R..-, percent 8 10 12 14 16 18 20 Monthly payment (principal and interest), a dollars Total intenllt b payment, dollan 82.080 107,966 135,150 163,280 192,060 221,275 250,785 366.88 438.79 514.31 592.44 672.38 763.54 835.61 .~ IntenIIt of total To~ paid, doIlan 62 88 73 77 79 82 83 132.oso 157,965 185.150 213,280 242,060 271,275 300.785 a. Excludes proparty taxes and insurance premiums. b. Assumes mortgage is held to maturity. their housing because of tax considerations. During inflationary periods, nominal incomes tend to rise, pushing individuals into higher tax brackets. The progressive nature of the U.S. tax system and the fact that interest deductions are concentrated in the early years of a mortgage may provide an incentive to sell and assume a new mortgage to maximize the tax-sheltering feature of housing. This is particularly true for individuals who have experienced substantial income growth, resultinq in a significant decline in the portion of income allocated to housing expenditures. The differential impact of housing price inflation also is evidenced by changes in the composition of participants in the home buying market. In one study of homes financed by savings and loans, first-time buyers accounted for 36 percent of all home buyers in 1977, but this percentage declined to 17 percent in 1979.8 While repurchasers generally "trade up" to larger homes, first-time buyers are concentrated at the lower-priced end of the market. In 1977, the median purchase price paid by first-time 8. See "Homeownership: Coping United States Savings League. with Inflation," buyers was $37,000, compared with $48,472 for repurchasers; in 1979, first-time buyers paid a median price of $48,950, compared with $60,600 for repurchasers. Although rising housing prices have a differential impact at the down-payment stage, this is not necessarily the case in financing the balance of the purchase price unless the repurchaser applies a large portion of his accumulated equity to the down payment, thereby reducing the amount financed by a mortgage loan. As mortgage interest rates rise, the proportion of the total payment devoted to interest over the life of the loan also rises (see table 2). To assess the impact of rising housing prices and interest rates on housing sales, the proportion of income devoted to housing may be considered on a yearly basis, using that year's median sales price of a new home, median household income, average effective mortgage interest rate, average down payment, and average loan maturity. By using the loan terms in effect for a specific year, it can be seen that the monthly payment burden has increased faster than income. Today's home buyer must allocate a substantially larger portion of current income to housing expenditures than was the case five years ago. In 1979, the median-income family purchasing a median-priced home allocated 27.1 percent of annual income to housing expenditures, compared with 16.4 percent in 1970 (see table 1). Moreover, these figures do not take into account the corresponding increases in property taxes, insurance premiums, and maintenance costs. On the other hand, the tax advantages of home ownership also have been excluded, although, as noted earlier, these may be a significant factor in the decision to purchase a home. Conclusion In summary, home ownership costs have increased substantially in the past three years, both as a result of inflation and the increase in real mortgage interest rates. Although innovative financing techniques and the increase in two-wage-earner families have overcome the barriers to home ownership to some extent, they are unlikely to put housing within the reach of many potential firsttime buyers. Single-family housing proved to be an excellent investment in the 1970s, when low real interest rates and accelerating inflation increased the demand for singlefamily housing. In the past three years, however, regulatory changes have integrated the mortgage markets with the capital markets, increasing the volatility and cost of mortgage credit. With the growing importance of variable-rate mortgage loans, home buyers also will face greater uncertainty with respect to their monthly housing expenditures. At the same time, government incentives to encourage investment in the nation's industrial sector are likely to reduce the attractiveness of housing as an investment. Given these factors, the climb of housing prices will likely be restrained in the 1980s. NOTE: No issues of the Economic Commentary were published in October. Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 Address correction requested o Correct as shown o Remove from mailing BULK RATE U.S. Postage Paid Cleveland,OH Permit No. 385 Economic Commentary ISSN 0428·1276 Current Perspectiveson Home Ownership by Judy Z, Menich Between 1970 and 1979, the median sales price of an existing single-family home rose roughly 170 percent, while the general price level increased 113 percent. The number of housing units also increased substantially: 17.8 million housing units were produced during the 1970s, or 24 percent more than in the previous decade.1 As the 1970s advanced, the role of housing shifted from primarily a consumption item to an investment item, a role that was further enhanced by declines in real after-tax returns on such financial assets as stocks, bonds, and savings accounts. Since late 1979, housing prices, adjusted for inflation, actually have decl ined. Moreover, the trend toward larger homes has reversed: the average size of a new house, which peaked in 1978 at 1650 square feet, has been decreasing since. Today's new list Please send mailing label to the Research Department, Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH 44101. November 2,1981 1. See "Housing: Sacred Cow," FRB SF Weekly Letter, Federal Reserve Ban k of San Francisco, November 28,1980. home buyers are faced with paying more money for less living space, although the price per square foot has declined somewhat since 1979. This Economic Commentary examines the underlying causes of the rapid escalation and subsequent deceleration in home prices, focusing on the economic developments that were the major stimulus to home ownership in the 1970s. Inflation and Housing Prices Historically, an increase in the general price level has been accompanied by a proportionate increase in housing prices; from 1950 until the mid-1960s, housing prices advanced at roughly the same rate as the overall inflation rate. During this same period, median family income grew at a Judy Menich is an economic analyst with the Federal ReserveBank of Cleveland. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal ReserveSystem.
@FedFRASER