My wife and I are looking at houses, and I’m struck by the amount of activity happening around us (southwest of Portland, OR). Especially in new developments, every office we walk into has multiple couples signing contracts. Talking to a mortgage broker, I was surprised to learn that the income-to-debt ratio they accept is 45% of gross. Which means, surprisingly, that a couple earning $60,000 a year could feasibly take on monthly housing costs of $2,250 (which approximates to a $400,000 mortgage assuming $400 in taxes and insurance). That seems like a lot of house for our couple. I’m wondering if the bubble days are coming back, or even what a bubble is.
My wife and I are a mini-economy all on our own. Let’s use the hypothetical finances of our $60,000/year couple who have $100,000 squirreled away (maybe they lived with their parents, who knows). Should they buy a half-million-dollar house? It depends on a few factors. Are they doctors at an early stage in their careers, expecting their incomes to jump 5x or 10x or 20x within the next 10 years? If so, then the mortgage looks positively cheap. Or are they blue-collar workers at a paint factory that bleeds money? Then they should think again.
Whether the debt is a trap is based on our expectations. My wife and I expect to earn more every year, so we can upgrade using more debt with the happy thought that the fixed payment will become lower and lower compared to our nominal income. The same is true of the economy as a whole. Liquidity traps happen when, for whatever reason, our nominal incomes don’t match the debt we took out in the first place. Healthy growth happens when we expect our wages to grow every year, so we take out just a little more than we can afford now. Bubbles happen when we count on the value of our asset increasing enough to offset our lack of income. In effect we’re borrowing to speculate on the future price of an asset.
I have to think that with more jobs, wages starting to tick up, and banks with huge surpluses of deposits over loans, all this buying I’m seeing isn’t a bubble. It’s the beginning of a shift in our expectations. The path of future interest rates matters too. If we think we’ll make more in the future, and houses are relatively inexpensive (ie. I can rent my house for more than I pay for a mortgage), then I should take on more debt now in case demand spikes and, with it, my interest rate.
We can thank the Federal Reserve for not tightening too much as soon as things looked brighter. But we should be wary of rate increases later this year. Jobs numbers look good and wages may be starting to turn the corner, but there’s still a lot of slack in prices out there. We need to collectively believe our incomes will go up in order to make it a reality.