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Affordability Impacted More By Pricing Than By Mortgage Rates

In David Berson’s weekly commentary this week he discusses how housing affordability falls as rates and prices increase [Fannie Mae] [1].

There is an inverse relationship between mortgage rates/housing prices and affordability. Rates and prices rise, affordability falls. Nothing new here. You have less disposable income to buy other things or you don’t make the qualifying ratios in order to obtain financing.

The NAR housing affordability index measures the share of the median-priced house (as defined as the median price of existing single-family homes sold in the monthly NAR home sales survey) a family earning the median income (as defined by the U.S. Bureau of the Census) can afford at the prevailing mortgage interest rate and using standard underwriting criteria. The prevailing interest rate is the effective rate on loans closed for existing homes from the Federal Housing Finance Board’s Mortgage Interest Rate Survey. The calculation also assumes an 80 percent loan-to-value ratio and a qualifying housing-to-income ratio of 25 percent.

These standards are a little outdated due to the 80% LTV and 25% ratio. There is a significant number of sales that relied on 90+% LTV’s and 33%+ H to I ratios. Ease of financing one of the triggers for the recent housing boom. Nevertheless, affordability was kept in check as prices increased because it was all about the monthly payment and not about the down payment.

What I find fascinating with the chart is the idea that affordability would be virtually the same today as this time 3 years ago had housing prices remained flat. If rates had remained constant, affordability would have dropped over the past 3 years.

In other words, the rise in housing prices is the bigger culprit in declining affordability, not the uptick mortgage rates.

Its an interesting concept because I am often asked what the mortgage rate threshold is before it causes a correction. I have been unable to come up with an answer I am comfortable with and perhaps this is why.

Note: Berson’s links lasts one week. After 9/6/06, go here and search for his 8/28/06 post. [2]