Housing demand growth is slowing, so why is housing inflation continuing at a steady pace more than twice the rate of the CPI? The answer is simple- tight supply and a mortgage rate subsidy that reduces the effective cost of a house to the buyer, thereby increasing the purchase price that buyers can pay.

The initial effective cost of a house purchase is the monthly payment. If you own a home or are considering buying one and if, like most homeowners, you have a mortgage, your first concern is not the price of the house. First you determine what you can afford to pay. This is based on the ratio of the monthly payment, what those in the industry call “PITI,” to your household income. Under the standard qualifying ratio,  the monthly PITI should not exceed 28% of gross household income. Buyers look at the cost of a purchase as being limited to that amount. Loan underwriting gets a little fuzzy around the edges, but there’s a market wide qualifying ratio limit somewhere just above that level. Once the preponderance of buyers in the market has hit that level, they can’t and won’t pay more for home purchases than that line in the sand. When that limit is reached, sales volume begins to recede and inventory increases. Sale prices then fall.

PITI really is a pity for us suckers who have mortgages. With insurance and taxes, in the end we pay a total of roughly 2.5 times the initial purchase price of the house to pay off the loan with interest, plus the taxes and insurance. That doesn’t even begin to account for the lifetime cost of maintaining the property. Houses depreciate physically if not maintained. More importantly they depreciate economically as market tastes change. If you haven’t remodeled your house to current standards at least once near the end of your 30 year holding period, it becomes a classic “fixer upper”. As we all know from the vast real estate expertise we gather from watching HGTV, fixer uppers are deeply discounted.

If we hold the property for 30 years, leverage and inflation could bail us out from our initial stupidity. But there are no guarantees. When all the long term costs of home-ownership are added up, in most markets you’d be lucky to break even.

While many buyers are aware of those facts, the long term cost is not the issue.