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Economic trends.


There is widespread agreement that housing affordability is a significant problem in the U.S., preventing many families from becoming homeowners. Although easily recognized, the problem of affordability is a very complex issue to analyze. Public perceptions of affordability problems often center on the level of home prices and/or home price appreciation, the level of interest rates and where they are headed, and the level of income and its growth. Further analysis suggests that the down payment hurdle may be the most significant of all the impediments to homeownership, particularly among young households. Beyond even these considerations, current tax law and expected future tax laws, saving behavior, expected future income, current and expected returns on assets (including capital gains on homes), current and expected future wealth, changing consumer preferences (e.g., larger homes with more amenities), mortgage product innovations (such as the initial introduction of adjustable rate mortgages or the initial extension of loan maturities) all directly or indirectly influence housing affordability.

The examination of many of these factors will be done in this and subsequent "Economic Trends" columns. A useful point of departure is one of the most fundamental affordability measures of all: the ratio of mortgage payments to income. This ratio provides a useful summary measure of the effects of changes in income, prices and interest rates on affordability. As the ratio rises, housing costs are becoming more expensive relative to income (i.e., less affordable); as the ratio falls, housing is becoming relatively more affordable.

Another reason this ratio is of interest is that it is the type of measure frequently used by mortgage lenders in their underwriting process. If the ratio is on the rise, it implies that some potential borrowers will not meet underwriting standards and will not qualify for mortgage credit--an unfavorable result for both the borrower and lender.

Chart 1 shows the payment-to-income ratio since 1963. From 1963 to 1973, the ratio averaged 14.1 percent, with a very mild upward trend. Then, it began to increase sharply. In the next eight years, it more than doubled from 15.9 percent in 1973 to 36.1 percent in 1981.

From 1981 to 1986, the ratio fell by almost as much as it had risen in the preceding four years, but not by enough to offset the full run-up of the 1970s. By 1990, the ratio is estimated to average 21.7 percent--about the same as in 1986.

The upward trend in the ratio during much of the period suggests that buyers needed to allocate an increasing share of their budgets to home-ownership (a least initially), or get squeezed out of the market. Even with the sharp decline in the ratio from 1981 to 1986, it stood higher in 1990 than at any time prior to 1979.

Chart 2, Panel A shows changes in the ratio; Panels B - D show the factors contributing to these changes. In Panel A, changes are positive when housing costs are increasing more rapidly than income, and affordability is declining. Changes are negative when housing costs are increasing less rapidly than income, or falling, and affordability is, therefore, improving.

Panel B shows the effects of home price changes on changes in the ratio. In every year, home prices increased (based on National Association of Realtors' data on median prices of existing homes sold), putting upward pressure on the payment-to-income ratio. The upward pressure was particularly strong in the late 1970s and in 1980, when prices were increasing at double digit rates.

Panel C shows that income had the opposite effect. Income growth (based on Census data on median family incomes) put downward pressure on the ratio in every year, which is reflected by the negative values in the chart. Taken together, Panels B and C suggest that the effects of price increases and income increases were roughly the same size, but offsetting. Therefore, if no other factors came to bear, the payment-to-income ratio would not have changed very much as a result of these two factors combined.

The final factor, movements in interest rates, accounted for most of the volatility in the ratio, as Panel D demonstrates. Generally rising interest rates (based on Freddie Mac data on contract rates on fixed-rate mortgages) during much of the 1960s and 1970s contributed to decreased affordability; falling interest rates during much of the 1980s contributed to increased affordability. In the past few years, mortgage interest rates have been relatively stable--varying only modestly around 10 percent--so the effect of interest rate changes on the payment-to-income ratio has been very modest as well. For this reason, the ratio has not changed very much since 1986.

Given that home prices and income are likely to grow at similar rates in the 1990s, the payment-to-income ratio is likely to decline only if interest rates decline. The MBA economics department forecast calls for a modest decline in mortgage interest rates in the next year or so, but substantial further declines in rates are only likely in the long run if inflation expectations are reduced and/or the federal budget deficit is cut further than currently expected. Unfortunately, significant progress on these long-term influences is likely to be difficult to achieve. [Graphs 1 to 2 Omitted]

Thomas M. Holloway Senior Economist
COPYRIGHT 1990 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Holloway, Thomas M.
Publication:Mortgage Banking
Date:Dec 1, 1990
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