Mortgage Affordability Metrics: A Brief Guide to an Important Equation
A key question that has emerged during the housing recovery concerns mortgage affordability. Despite slow but steady economic growth and a halving of the overall unemployment rate to under five percent, the ability for a typical family to afford purchasing a home remains a significant challenge.
In April 2016, a typical new home cost more than $321,000, and the typical existing home sold for more than $232,000, according to U.S. Department of Commerce and National Association of Realtors® data.
Additionally, Zillow data indicate that the minimum income required for a mortgage payment on a median-valued home in metropolitan areas across the United States rose from $49,752 in the first quarter of 2009 to $55,753 in the first quarter of 2016, an increase of about 12 percent, as shown in the accompanying chart.
Amidst ongoing concerns about mortgage affordability, several organizations have regularly produced data sets and matrices to assess affordability.
According to economist Nuno Mota of Fannie Mae’s Economic and Strategic Research Group, these metrics fall into two different categories, each of which is useful in different ways, but each of which also has drawbacks as a way of measuring home affordability:
Household-level metrics measure whether a typical household can afford the costs of homeownership including the mortgage payment (principal and interest). These metrics can take the following forms:
- Housing cost-to-income ratios measure the cost of homeownership as a percentage of total household income. Generally, a household is considered cost-burdened if housing costs are more than 30 percent of total household income.
- Residual income approaches measure how much income is left over to the typical household after the mortgage payment is made. This measure typically varies by the number of people in the household, which would require different levels of spending (for food, clothing, or other costs).
Both kinds of household-level metrics have drawbacks.
Household-level metrics reflect personal choices consumers have made — buying a larger home to accommodate a growing family, for instance. This may create difficulty in the short term, but may be a rational choice if the buyer expects the home to be affordable over the long term.
In addition, not all housing types — including affordable housing — are available in all areas.
On the other hand, market-level metrics determine what percentage of potential homeowners in a typical market can afford the median-priced home. The challenges of these types of metrics are that they do not account for the diverse nature of homebuyers and the home buying process. For example, the figures are typically not seasonally adjusted and do not account for the differences between new and existing homes.
In the final analysis, Mota recommends that a mix of measures is appropriate for developing a broad view of the cost burdens for individuals, coupled with a market-level view of mortgage affordability. He noted that nearly 40 million Americans experienced a serious housing cost burden in 2015, whether they were renters or homeowners.
Further, as The Home Story noted earlier this month, while the number of cost-burdened owner households is falling, the number of cost-burdened renter households is increasing, suggesting the nature of the affordability challenge may be changing.
Anne McCulloch, Fannie Mae’s senior vice president for credit and housing access, agrees and notes that Fannie Mae’s HomeReady® mortgage product recognizes the changing income dynamics of the American household: “HomeReady allows income from a non-borrower household member to be recognized as support for higher debt-to-income ratios in certain circumstances, reflecting the additional income that is available in the household to cover expenses,” she says.
“To successfully serve families of modest means [Fannie Mae] needs to examine the challenge of affordability from many perspectives,” she adds.