Housing affordability will be at its highest in a generation this year

Housing affordability will  be at its highest in a generation this year.

The affordability index is comprised of median home prices, median family income, and the prevailing mortgage rate. An index of 100 implies that a median income family has just enough income to buy a median priced home. An index of 120 implies that a median income family has 20 percent more income than is necessary to buy a median priced home. The index reached an all-time high (since the data creation in 1970) of 174 in 2010. This year, it looks to surpass 180. The rising affordability is a combination of lower home prices, record low mortgage rates, and a slight rise in family income.

In short, there hasn’t been a better home buying opportunity in 40 years.

However, not all people have the necessary confidence to make a major expenditure like a home purchase in an uncertain economic environment. More importantly, the underwriting standards are overly stringent. Those who are currently able to get conforming mortgages have an average credit score of 760. Under normal underwriting standards (and not the lax underwriting of the bubble years), credit scores would be closer to 720 on conforming mortgages. For FHA mortgages, today’s borrowers have an average credit score of 700, compared to historic FHA borrowers who had an average credit score of 660. If the underwriting standards were just to return to normal then there could be an additional 15 to 20 percent increase in home buying activity.

Banks have plentiful cash reserves but are unwilling to lend. They are blaming the regulators, saying extra cash holding is needed in case of another catastrophic economic event and because the banks are uncertain about future regulatory rules. Under these circumstances any additional attempts by the Federal Reserve to lower interest rates via another third round of Quantitative Easing (QE3) and printing more money would be inconsequential to the housing market. All the while, printing money could pose higher inflation risks in the not-too-distant future. Simply getting the excess cash holdings held by the banks out to the borrowers will be the true, natural stimulus for the economy.

Source:  Lawrence Yun, Chief Economist & Senior Vice President, Research, National Association of Realtors

A primer on housing affordability

Buying a house is a huge decision. Here's a way to help determine how much you can afford and if now is the time to buy

By Marc Roth

 

Recently, my good friends Steve and Randy (the parents of two adorable kids) decided it might be time to trade up fromtheir three-bedroom, two-bath town home to a four-bedroom, two-and-a-half-bath house.

While Steve has a stable job—Randy stays home with the kids—he is very conservative and spent weeks crunching numbers to determine whether they could afford the move.

When I first heard Steve was putting in all that time, I thought: "Good for him. He's doing everything possible to avoid becoming a causality of the housing meltdown."

But the more I thought it, the more I realized figuring out how much house you can afford, and determining whether now is a good time to be buy shouldn't be that hard.

So, to make Steve's, Randy's, and your lives easier, I set out to simplify the process.


My goal was two-fold. First, I wanted to create a hard-and-fast rule for how much you can afford to spend on a house. Like you, I have heard suggestions ranging from 28% to 40% of income, but I have always had problems with that. For one thing, that is an awfully big range. If your family income is $140,000 a year, depending on which people you listen to it means you can spend anywhere from $3,266 to ( $4,666 a month. That's a huge spread. For another, those guidelines apparently don't work very well, as the recent mortgage mess proved.

Plug In the Formula

My second goal was to see if there is a simple way to figure out, on an objective basis, whether now is a good time to buy.

There is a tremendous amount of information available on housing affordability. For example, the National Association of Realtors (NAR) has its Housing Affordability Index (HAI). This number is designed to track how affordable the average home is at any given moment. It does this by dividing the average monthly household income by the average income a family would need to qualify for a mortgage.

To illustrate how this works, let's take a look at the data for the year ending 2006. The median U.S. family income was $58,400, and the average qualifying income required to obtain a mortgage was $54,300. Dividing the family income by the qualifying income, we get a HAI ratio of 108. By itself, this is sort of interesting but not particularly useful.

But let's compare that number with today.

We'll begin by going back to the HAI formula—average monthly household income divided by the income you need to qualify for a loan. We know what our average family income is, right? It's how much we make per year (or per month if dividing by 12).

What is qualifying income, you ask? Good question! According to the NAR, it is the amount you would need to pay your mortgage, taxes, and homeowner's insurance if you put down 20% of the purchase price. NAR says that should work out to be 25% of your gross monthly income. Not only do I like this definition, but I love it that they are using a conservative 25% of income as a rule of thumb for how much you can afford. I have decided to adopt it as my own.

More Affordable Nowadays

So let's get back to our 2006 example when the HAI was 108.

At that time, the average national home price was $221,900, and the average 30-year fixed-interest-rate was 6.58%. So, the NAR figured out that if buyers put down 20% (around $44,000) to buy a $221,900 home, it would cost them approximately $1,131 per month for mortgage, taxes, and insurance. That made the income needed to qualify: $54,288.

Flash forward to today. As of June 30, the HAI, which peaked at 179 in April, was at 159. That meant for the average person, the cost to buy a house was dramatically less than it was three years ago.
Why? Well while the median income was only up slightly—it stood at $60,671 in June— the qualifying income had fallen dramatically to $38,160.

What accounts for the drop? Substantially lower mortgage rates for one thing—they stood at 5.16% in June down from the 6.58% three years before—and lower home prices. The average home was going for $181,900 in June, down from $221,900 in 2006.

The obvious conclusion: Houses have become way more affordable today.

I know what you're thinking. How could my friends have used this information in deciding whether to buy? After all, what do they care about national averages, all they should care about is their situation.

Absolutely true. Next time, we will talk about how Steve, Randy, and you can put this information to good use.

Marc Roth is the founder and president of Home Warranty of America, which touches just about every part of the real estate industry since it sells through builders, real estate agents, title companies, mortgage companies, and directly to consumers.