Are Current Home Prices Sustainable?

Home prices have entered into peak levels not witnessed since 2006, causing a growing concern in the industry about the long-term sustainability of current home prices.

Freddie Mac's monthly insight report for May dives deeper into the phenomenon of rising home prices by explaining what risks they pose and how to access the risks.

Between 2006 and 2011, home prices declined about 25 percent, and in turn, erased $6.2 trillion in housing wealth, Freddie Mac said. As a result of the drop in prices, almost 23 percent of borrowers found themselves underwater, owing more on their mortgages than their houses were worth, delinquencies and defaults skyrocketed, almost two million borrowers lost their homes to foreclosure and short sale, and the homeownership rate in the U.S. dropped from 69 percent in 2006 to less than 64 percent today.

U.S. house prices rose 1.3 percent in the first quarter of 2016 and 5.7 percent year-over-year, according to the Federal Housing Finance Agency (FHFA) House Price Index (HPI).

The report noted that this will mark the nineteenth consecutive quarterly price increase in the purchase-only, seasonally adjusted index and the fourth consecutive year in which prices grew more than 5 percent.

"House prices have breached the peak levels of 2006, raising concerns about the long-term sustainability of current price levels," said Sean Becketti, Chief Economist, Freddie Mac. "The difficulty of forecasting house price appreciation and the conflicting signals of the multitude of house price metrics make it challenging to assess whether—and where—house price risk is indeed increasing."

Freddie Mac suggests two methods to gauge home price risk. The first stage compares the prices of recent sales to household incomes to pinpoint areas that merit further scrutiny, and the second stage checks whether additional indicators suggest that house prices in the highlighted areas are headed for a fall in the future.

"Our first stage identified ten large metro areas with unusually-high house prices relative to the household incomes in those areas. However, the second stage failed to produce compelling evidence of increasing house price risk," Becketti said. "As long as leverage remains low, home owners will remain resilient in the face of economic fluctuations. However, if leverage creeps up, home owners' financial cushion will shrink, leaving them more vulnerable to economic shocks. In sum, our analysis suggests that, aside from isolated areas, we don't need to worry about house prices—yet."