(MoneyWatch) Call it the affordability myth.
For months now, the housing market has appeared wildly attractive to buyers, thanks to extremely low interest rates and still-depressed home prices. But those low interest rates may actually be masking a fundamental flaw in the housing market -- home price gains are outpacing income growth. While home prices are still low, Americans don't necessarily have the income to pay for them.
Historically low mortgage rates are translating into big savings for homeowners. American homeowners paid almost 37 percent less per month in mortgage payments in the fourth quarter of 2012 compared to pre-housing-bubble norms. Yet homes themselves cost 14.5 percent more in the fourth quarter compared to historic averages relative to U.S. median incomes, according to online real estate site Zillow.
Comparing home prices to median income data from the U.S. Census and the Bureau of Labor Statistics, researchers at Zillow found that U.S. home buyers are spending three times their annual incomes on the purchase price of a home. But in the pre-bubble period from 1985 to 1999, Americans were only spending 2.6 times their annual income on the purchase price of the home.
Put another way, someone making $100,000 annually in the pre-bubble period was buying a home worth about $260,000, while someone making $100,000 now is buying a $300,000 home. Yet, that $300,000 home now will cost the homeowner less over the life of the mortgage than that $260,000 home.
Today's interest rates make that possible. The average interest rates before 1999 hovered between 6 percent and 13 percent for a 30-year fixed mortgage. At the end of the fourth quarter of 2012, interest rates stayed between 3 and 4 percent.
But what happens if? Home prices jumped an average of 8 percent from 2012 to 2013, according to the Case-Shiller home price indices. If they continue to climb at that rate (or even a bit less), that affordability may well be wiped away as American incomes simply can't keep pace.
"The days of historically high levels of housing affordability are numbered," Zillow chief economist Stan Humphries said. "Current affordability is almost entirely dependent on low interest rates, and there's no doubt that rates will begin to rise in the next few years. This will have an undeniable effect on demand for housing, as homebuyers will have to spend more of their incomes to buy a home."
If interest rates increase, and they likely will, that could mean that home values might soon hit their growth peak. Unless lending standards loosen or income grows, home prices would then remain stagnant or even drop in some areas.
"This will especially be the case in some markets that have seen strong home value appreciation," he said.
Homeowners in 24 of the 30 largest metros covered by Zillow were paying more for homes in the fourth quarter of 2012 relative to their region's median income than they were from 1985 through 1999. Metros with the largest difference between their pre-bubble and fourth quarter 2012 price-income ratios included San Jose (52.1 percent more), Los Angeles (48.8 percent), Portland (45.4 percent), San Diego (44.6 percent) and Denver (40.8 percent).
Of the 30 largest metros covered by Zillow, only Cincinnati (3.1 percent less), Chicago (3.9 percent), Cleveland (6.7 percent), Atlanta (13.9 percent), Las Vegas (14.6 percent) and Detroit (25.5 percent) posted price-income ratios in the fourth quarter of 2012 that were less than historic norms.
Home prices cannot grow endlessly in a vacuum. Without growth in the jobs and income levels that allow Americans to purchase homes, the housing recovery will not be able to continue at this pace.