In the past month, mortgage rates have been increasing due to rising inflation. Home prices have also been appreciating strongly with not enough homes on the market. Rising home prices and mortgage rates affect home affordability. In this blog post, I will analyze how higher mortgage rates and higher home prices impact home affordability.
A simple way to measure home affordability is to look at the share of mortgage payments to income. NAR considers a mortgage payment as unaffordable if the mortgage payment exceeds 25% of income so that taking other housing expenditures into account (e.g., property taxes, mortgage insurance, maintenance, and utilities), housing costs don't exceed 30% of income. HUD considers housing costs to be burdensome if housing-related expenditures exceed 30% of income.
Another way to measure home affordability is to compare the income that a family has to the income that a family needs so that the mortgage payment is affordable (mortgage payment is equal to 25% of income). NAR calls this ratio (multiplied by 100) the Housing Affordability Index (HAI). An index of 100 means that the median family income is more than the income needed so that the mortgage payment is equal to 25% of income (qualifying income). NAR estimates monthly housing affordability indices at the national and regional levels.
Baseline: Mortgage rate and home affordability as of February 2021
As of February 2021, the 30-year fixed mortgage rate was 2.73%. The median single-family home price was $317,100. The median family income was $85,817. At a 20% down payment, the mortgage payment was 14.4% of income.
In analyzing the effect of higher mortgage rate, home prices, and income on home affordability, I analyze a scenario where the 30-year fixed mortgage rates increase to 4%. For home price and income growth, I used the following assumptions:
- NAR latest forecast existing-home price change in 2021: 9% year-over-year growth.
- Federal Reserve Bank of New York's Survey of Consumer Expectations: income growth of 2.8%.
Scenario 1. The 30-year fixed mortgage rate rises to 4% and the median single-family home price rises by 9%.
In this scenario, the monthly mortgage payment goes up $297 dollars from $1,033, to $1,330 dollars monthly. Mortgage payment as a percentage of income increases to 18.6% from 14.4%. The qualifying income increases to $63,840 from $49,584. The HAI falls to 134.4. So, a home purchase is still affordable (index is over 100) but a home purchase has become less affordable than before.
Scenario 2. The 30-year fixed mortgage rate rises to 4%, the median single-family home rises by 9%, and median family income rises by 2.8%.
In this scenario, the mortgage payment as a percentage of income increases to 18.1 from 14.4. The median family income increases to $88,220 from $85,817. The HAI falls to 138.2 from 173.1. A home purchase is still affordable, but less affordable compared to the baseline, although more affordable compared to Scenario 1.
HAI housing is still affordable and the median family income is higher than the qualifying income needed to afford a home. However, higher mortgage rates and prices will cut into affordability.