Housing Costs and Non-Housing Consumption

Author: Heather M. Luea

Dissertation School: Newman University

Pages: 59

Publication Date: 01/2006

Availability:
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Access Number: 5009

Abstract:

From 2000 to 2003, the average annual 30-year fixed mortgage rate fell, which prompted unprecedented home purchase activity and refinancing. The transactions in the housing market have continued to be high through 2005. The homeownership rate is now the highest in the history of the United States housing market (HUD, 2003). More than 68 percent of the households in the United States are homeowners, and the majority of these homeowners have mortgages. Mortgage financing options have become more diverse and creative. In December 2002, for example, 14 percent of the loan base was comprised of adjustable rate mortgages (ARMs). By December 2004, that fraction had grown to 34 percent (Freddie Mac, 2005). In some cities, such as San Diego, 60 percent of the loan base is comprised of ARMs (Jeske, 2005). This growth in ARMs is in part because homeowners have enjoyed increasing housing prices and falling interest rates and likely anticipate these trends will continue. In San Diego, where such a high fraction of home loans are ARMs, the 2004 median home price was among the highest in the nation (Freddie Mac, 2005). Since June 2004, the Federal Reserve has increased the Federal Funds rate several times. In November 2005, the Federal Funds rate was 2.5 percent higher than it was in June 2004, and subsequently, mortgage interest rates have been on the rise (FRED, 2005). As interest rates rise, housing costs rise, particularly for those homeowners with ARMs.

In light of the prevalence of ARMs and the likely continuing rise in interest rates, one important question is: to what extent do housing cost burdens impact non-housing consumption? In particular, how do households bear increasing housing costs? Do they adjust non-housing consumption as housing costs change, and, if so, to what extent do they alter this type of consumption? Alternatively, they may temporarily incur higher debt in response to higher housing costs and keep non-housing consumption constant. Importantly, if households substitute away from non-housing consumption as interest rates rise, this could have implications for the macroeconomy.

This essay examines housing cost burdens and the extent to which high housing cost burdens impact non-housing consumption. Housing cost burdens may increase due to a fall in income or a rise in housing costs due to a change in housing tenure, second mortgage financing, or a rise in interest rates. Using a 4-year panel of household data, I investigate household's responsiveness to high housing cost burdens, while controlling for unobserved heterogeneity. The results indicate housing cost burdens affect the level of food expenditures, and, in particular, households with high housing cost burdens have lower expenditures on food than similarly situated households with low to moderate housing cost burdens. Although research has been done regarding housing affordability, no study to date specifically examines the relationship between housing cost burdens and non-housing consumption. This study is also important because it uses the most recent household housing cost and financial profiles available from the Panel Study of Income Dynamics (PSID).

Using both a cross-section and panel dataset from the PSID, I find households with high housing cost burdens earn substantially less income, have higher housing costs, and spend less on annual food consumption. Although small in magnitude, the coefficients suggest non-housing consumption falls as housing cost burdens rise, warranting a closer examination of the relationship between housing cost burdens and non-housing consumption. This essay also provides a closer look at the differences between households with low housing cost burdens and those with high housing cost burdens. The results are dramatic, suggesting that if low burdened households unexpectedly experience high housing cost burdens, the household's annual food consumption will fall by roughly $349. Furthermore, the analysis suggests that movers experience non-housing consumption shocks during the early years following a move. Specifically, movers consume $4,124 less in total food expenditures and $1,120 less in restaurant meals initially following a move as compared to the fifth year following a move, suggesting that in the early years following a move, households substitute housing consumption for non-housing consumption.

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