Why Housing Affordability Is a Mirage

Why Housing Affordability Is a Mirage

by | Jun 18, 2012 | News

Home prices and mortgage rates have made monthly mortgage payments lower than at any time in the past decade. But housing isn’t any more affordable than it was five years ago, during the go-go lending days, after factoring in down payment requirements and other financing terms, according to a new paper.

The National Association of Realtors and other housing economists typically measure housing affordability by looking at home prices and mortgage rates. Prices of course have fallen to nearly 10-year lows nationally, while rates have never been lower. Freddie Mac on Thursday said rates stood at 3.71% this past week for the average 30-year fixed-rate mortgage.

But the total cost of homeownership, as a share of a borrower’s income, is the same today as it was during the height of the housing mania, according to the study by Andrew Davidson and Alexander Levin of mortgage consulting firm Andrew Davidson & Co.

The reason: borrowers have to put more money down to get a loan, and the exotic lending products that allowed borrowers to make low initial payments have gone away. That means while the absolute monthly payments are lower, the all-in costs of homeownership haven’t become more favorable.

Today, most lenders require minimum down payments of 20%, though loans with down payments of just 3.5% are still available through the Federal Housing Administration. During the peak of the housing boom, borrowers could bypass pesky down payments by taking out second mortgages or obtaining mortgage insurance.

“Home affordability needs to be considered in light of the full financing package,” said Mr. Davidson. “During the bubble the low all-in cost of mortgage financing allowed borrowers to purchase homes, even at inflated prices.”

The erosion of down-payment requirements from 2000 to 2006 reduced borrower costs by around 15%, according to Messrs. Davidson and Levin, while tighter down-payment standards since 2006 have raised borrower costs by 22%. That more than offsets the benefit of a drop in interest rates from around 6% to less than 4%.

At the peak of the housing bubble, loan payments were the only cost that borrowers had to consider given the ability to take out no-money-down loans. But today, loan payments constitute roughly 50% of the total cost of ownership “and are rather modest by historical standards,” the paper says. “This explains why the record-low interest rates do not impress borrowers and do not propel home prices up.”

The authors estimate that the all-in cost of a home purchase stood at more than 9% of the property value in 2011, compared to around 7% in 2006. The gap is even wider in states like California, where borrowers took advantage of exotic loan products during the boom. As a result, rising interest rates could be more than offset by more flexible underwriting standards.