by Calculated Risk on 11/21/2005 10:32:00 AM

Fannie Mae's Molly R. Boesel writes: Home affordability suffers as home prices and interest rates rise.

Affordability has dropped sharply over the past 18 months despite low mortgage rates and a pickup in income growth. The National Association of Realtors’ (NAR) housing affordability index is at its lowest level since 1991 (and, using our own calculations, affordability has fallen to the lowest levels since the early-to-mid 1980s in some high cost areas). The NAR first-time homebuyer index is at its lowest level since 1985. What has caused this decline in affordability? We don’t have to go far to find the cause: the unprecedented rise in home prices. Dramatic increases in investor/second home purchases, looser overall underwriting, and the proliferation of low initial-payment ARM mortgages have all contributed to a surge in home prices relative to income growth. With further increases in mortgage rates anticipated over the next year, affordability should drop further.

Just a note - it appears mortgage rates dropped last week and might drop further this week. I'm not suggesting rates have topped, but it is possible (edit: possible short term) and that would help support house prices.

The chart below shows the NAR composite affordability index for the United States as a whole and the four Census Regions through September. An index value of 100 means that a family earning the median income has exactly enough income to qualify for a mortgage on the median-priced home -- and thus that it can afford to purchase 100 percent of the median-priced home. The September U.S. index value of 119.4 indicates that the typical family has 19.4 percent more income than needed to qualify for the median-priced home.

While affordability increased a bit in September, it is still well below year-ago levels, and the trend is clearly downward. Moreover, the biggest portion of the recent increase in mortgage rates has occurred over the past two months -- suggesting that the affordability index will decline once those higher rates are factored in. The last time the national affordability index was this low was when mortgage rates were around nine percent (in 1991). Regional affordability indices have also fallen, especially in the West.

How much of the drop in affordability has been due to house price increases and how much to increases in mortgage rates? The national affordability index fell by 19 points from September 2004 to September 2005. Over that time the median existing home price increased by over 14 percent and the prevailing mortgage rate increased by 20 basis points. Holding income constant, and alternatively holding the median sales price and prevailing interest rates constant, we find that 85 percent of the decline in the index over the past year came from the increase in the median sales price. Mortgage rate increases have been modest over the past year, while increases in income have outweighed any loss in affordability from the rise in rates.