Affordability Part 2 - Some Numbers

Part 2 How to define affordability? Historically, there have been several definitions of affordabilty used by different groups. I'll include a Seattle area numbers example with each one. There is a lot of debate right now about whether someone with the median income should be able to afford a median priced house or not. This is argued a lot because it isn't realistic for the bottom 20% or so to own a dwelling. Some have shifted up the median income to the 60th or 70th percentile to compensate. I'm a populist at heart and bearish on housing so I won't be doing that. In this post I'll cover two methods of affordability calculation 1. 2.5x household income, somewhere along the line people shifted this to 3x household income, I'm not sure if that has to do with lower interest rates or expecting to pay more for a house. Pros: Simple, easy to remember Cons: Does not take interest rates into account - thus does not directly correspond with monthly payments, and we are, by and large a monthly payment society. Does not take into account property taxes or homeowners fees Example: Seattle median family income is $69,000 a year, approximately, using 3x rule they can afford a dwelling unit that costs $207,000 (If you are lucky you can grab a small condo for that price, though I'm not sure where the rest of your family will go). 2. 28% of gross household income devoted to monthly payment, not more than 35% debt to income ratio (DTI). The DTI number varies somewhat, but the 28% is generally pretty rock solid. This is a number that is generally used by reputable lenders to determine loan eligibility. The problem with this figure is when the 28% is calculated on the payment for the first 5 years of an ARM that will be reset to a much higher payment in 5 years time. We are seeing some of those effects now. Pros: Takes interest rates into account, works well for the monthly payment society. Usually the 28% includes property taxes and insurance, but not always Cons: Loan term often not taken into account, can allow pretty large debt load, as figure is calculated as % of gross, rather than net income. Example: The median Seattle family earns 69k a year or $5750 a month before taxes. That leaves them with $1610 to pay towards a dwelling unit and taxes. after taxes and insurance they would have around $1300 to $1400 to make their mortgage payment. Splitting the difference gives $1350, which at 5.25% apr means $245,500 of house for our average family. This will actually purchase a home in the suburban fringe or in a more 'exciting' neighborhood in a more central location.