Monday, September 8, 2008

What does the take over of Fannie and Freddy Mac mean?

Sometimes its worth looking at what's happening in the larger world and think about what it means for you. With the US Government announcing the nationalization of Phoney and Fraudie, [Editor: Fannie Mae and Freddie Mac, thank you] think about what this means to you in your working life.

Through most of US capitalistic history, housing prices were about 3 to 4 times after tax income. This is not exactly true, but if you think about how much one can afford to pay on loans, it's reasonable.

If you consider that the average household income in the US is around $44K, the median is about $43K, to make the math easy, lets go with a pretax income of $45K. assume that around 33% will be paid in taxes, so the take home income will be $30K, or an after income of $2,500 per month.

The average home price in 2004 was about $264K, the median household price was about $221K. To make the math easy, let's go with a house price of $250K. On a 30 year, 6% interest loan, the monthly payment would be about $1,500. That means the average household is paying about 60% of their after tax income in house payments. Not sustainable.

For comparison purposes, if we look at the average house price in 1989, it was $120K, the average household income was $30K, so the median, after tax take home pay was $1,675. With an average monthly payment of $720, after taxes, homeowners paid 43% of their income for their house. Still high, but there have been a lot of assumptions made, so it's probably closer to 35%, but it's really only for comparison purposes.

As a point of reference in 2004, average rent price was about $650 per month, or about 26% of monthly, after tax income.

Now, let's just say, for the sake of argument, that someone makes the reasonable assumption that they don't want to pay more than 1/3 of their after tax income to own a home. That means that someone earning $45K doesn't want to pay more than $825 per month. On our same 30 year, 6% interest loan, that means the average home price would be about $138K.

Compare this amount to the average home price in 2004 of $264K, and you've got to think house prices can drop drop another 50%. In places like California, it could be even worse, considering the median income is $54K and the median home price is $514K.

If housing prices drop that much, how much will other assets fall? What will this mean for you?

Data information:

Home prices 1989:

Real median income 2004:

Real median income 1989:

Rental price information:

Average home sales price in 2004:

Average and median prices of homes between 1963 and 2007:

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