HOUSING FINANCE POLICY CENTER

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1 HOUSING FINANCE POLICY CENTER URBAN INSTITUTE The Impact of Mortgage Rate Increases on Housing Affordability Large Geographic Variations Lan Shi and Laurie Goodman Urban Institute November 2013

2 About the Authors Lan Shi was a research analyst at the Urban Institute at the time this paper was written. Laurie Goodman is the director of the Housing Finance Policy Center at the Urban Institute. We thank Ellen S. Seidman for her insightful and extensive comments and Pamela Lee as well as Fiona Blackshaw for their excellent editorial assistance. Copyright November The Urban Institute. Permission is granted for reproduction of this file, with attribution to the Urban Institute. The Housing Finance Policy Center (HFPC) aims to more effectively connect housing policy and housing finance, and to provide timely, impartial analyses of policy issues, anticipating problems and potential solutions and responding to them as they emerge. HFPC will enable the Urban Institute s work to both inform and be informed by greater understanding and analysis of how finance and financial regulation, monetary policy, and global capital flows shape and impact the US housing market, including the structure of housing credit (both ownership and rental), who is able to access that credit, and on what terms. The Urban Institute thanks The Citi Foundation and The John D. and Catherine T. MacArthur Foundation for providing generous support at the leadership level to launch the Housing Finance Policy Center. We also thank the Ford Foundation and the Open Society Foundation for their additional support. The Urban Institute is a nonprofit, nonpartisan policy research and educational organization that examines the social, economic, and governance problems facing the nation. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

3 Contents The National Picture of Housing Affordability 2 Regional Variations in Home Affordability 3 The Standard Method, Using 28 Percent DTI for All MSAs 3 Using MSA-Level DTI 5 Incorporating Variation in LTV across MSAs 9 The Impact of a Mortgage Rate Increase on Affordability 13 Conclusion 14 References 15 Notes 16

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5 The Impact of Mortgage Rate Increases on Housing Affordability By most measures, the US housing market appears to be in strong recovery. House prices have risen consistently since January 2013 (figure 1), and by August, the US median home price was the highest it had been since December As a result of a stronger economy, mortgage rates also have increased consistently since December Though rising mortgage rates and house prices indicate that the country is in a housing recovery, they also indicate a shifting landscape for housing affordability. Figure 1. Median House Prices and 30-Year Fixed-Rate Mortgage Rates, Median House Price 30-yr Mortage Rate $260,000 $240,000 $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 Feb-00 Aug-00 Feb-01 Aug-01 Feb-02 Aug-02 Feb-03 Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug % 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Sources: CoreLogic Home Price Index for median house price data; Freddie Mac Primary Mortgage Market Survey for mortgage rate data. To measure the impact of the housing recovery (that is, housing price and mortgage rate increases) on home affordability, we adapt the methodology used by the National Association of Realtors (NAR) in its Housing Affordability Index (HAI). 1 We measure affordability in the United States and across the 37 largest Metropolitan Statistical Areas (MSAs). We compute the maximum affordable price, given the median household income and the prevalent mortgage rate, and then compare it with the median house price. The higher the maximum affordable price relative to the median house price, the greater the affordability; the lower the maximum affordable price relative to the median house price, the greater the unaffordability. We use family income data from Census reports maintained by the Federal Financial

6 Institutions Examination Council (FFIEC), house price data from CoreLogic s Home Price Index (HPI), and mortgage interest rate data from the Freddie Mac Primary Mortgage Market Survey (PMMS). The National Picture of Housing Affordability We first look at long-term affordability nationally by analyzing trends in median home sales prices (based on CoreLogic s HPI) and maximum affordable home prices between 2000 and The maximum affordable price estimates the price a family earning the median income can afford. It is based on the following assumptions: a front-end debt-to-income (DTI) ratio of 28 percent, 2 a 20 percent down payment, a 30-year fixed-rate mortgage at Freddie Mac s prevailing rate at the time, and property tax and homeowner s insurance at 1.75 percent of the house value. Based on these estimates and a standard mortgage payment formula, we compute the maximum affordable price that a family with the median income can support. In figure 2, we plot median home prices and the maximum affordable home prices. Several observations stand out: 1. During the bubble (shaded in blue), the gap between the median home sales price and the maximum affordable price was significant. At some points, the median sales price was nearly 17 percent higher than the maximum price affordable to the median household. In other words, the median home sales price was not affordable to the median household. 2. Conversely, during , the maximum affordable price was quite close to the median sales price. 3. Since the bubble, the maximum affordable price has been higher than the median sales price, reflecting the drop in house prices and interest rates during the Great Recession. In fact, for most of the five years following the bubble s burst, the maximum price affordable to the average household has increased and the median home sales price has decreased, indicating that housing has become more affordable. 4. Beginning in December 2012, however, house sales prices have been increasing quickly and the maximum affordable price has been dropping due to rising mortgage rates. Therefore, home affordability is quickly declining. 2 Housing Finance Policy Center

7 Figure 2. National Housing Affordability, Median Sales Price Max Affordable Price Max Afd Prc LTV Adj Max Afd Prc at 5.0% Max Afd Prc at 6.0% $300,000 $280,000 $260,000 $240,000 $220,000 $200,000 $180,000 $160,000 Credit bubble $140,000 $120,000 Sources: CoreLogic HPI for median sales price data; FFIEC for median family income data. Notes: The maximum affordable price is calculated as the house price that a median family income can afford based on the following assumptions: 20 percent down payment, 28 percent front-end DTI, Freddie Mac prevailing mortgage rate for a 30- year fixed-rate mortgage, and property tax and homeowner s insurance at 1.75 percent of housing value. Max Afd Prc LTV Adj is the maximum affordable price where the current average loan-to-value ratio is used instead of the assumed 80 percent. Max Afd Prc at 5.0% is the maximum affordable price adjusted for LTV at a hypothesized mortgage rate of 5.0 percent. Max Afd Prc at 6.0% is the maximum affordable price adjusted for LTV at a hypothesized mortgage rate of 6.0 percent. Regional Variations in Home Affordability The Standard Method, Using 28 Percent DTI for All MSAs The national-level analysis masks huge variations in housing affordability across regions and MSAs. Recently, Nothaft and Kiefer from Freddie Mac s Office of the Chief Economist computed maximum affordable house prices across the 30 largest MSAs. For their study, the authors use an across-the-board front-end DTI ratio of 28 percent to calculate the maximum affordable house price under different interest-rate scenarios. Their findings indicate that several MSAs are extremely unaffordable in higher interest-rate environments. For example, based on data from March 2013, a 4.5 percent interest rate in the New York metropolitan area would yield a maximum affordable housing price of $285,000 at a time when the median home price was $379,000 (Nothaft and Kiefer 2013). We replicate Nothaft and Kiefer s findings with August 2013 data, calculating the maximum affordable house price using 28 percent DTI across all MSAs (table 1). New York, Los Angeles, and similarly notoriously high-priced MSAs have lower maximum affordable prices than median home prices. Indeed, The Impact of Mortgage Rate Increases on Housing Affordability 3

8 the discrepancy between the maximum affordable house price and the median home price has become even more pronounced than Nothaft and Kiefer found using March 2013 data. Figure 3 ranks MSAs by affordability using this standard method. Table 1. Housing Affordability by MSA, Using 28 Percent DTI Median family income Monthly funds for housing Median house sale price Max affordable price under 4.46% Max affordable price under 6.0% Metropolitan division New York-White Plains-Wayne, NY-NJ $66,000 $1,540 $500,000 $280,366 $246,213 Los Angeles-Long Beach-Glendale, CA $61,900 $1,444 $430,500 $262,949 $230,918 Chicago-Joliet-Naperville, IL $73,400 $1,713 $200,000 $311,801 $273,819 Houston-Sugar Land-Baytown, TX $66,200 $1,545 $191,250 $281,215 $246,959 Atlanta-Sandy Springs-Marietta, GA $66,300 $1,547 $185,000 $281,640 $247,333 Washington-Arlington-Alexandria, DC-VA-MD- WV $105,900 $2,471 $360,100 $449,860 $395,061 Dallas-Plano-Irving, TX $69,000 $1,610 $206,899 $293,110 $257,405 Riverside-San Bernardino-Ontario, CA $62,600 $1,461 $245,000 $265,923 $233,530 Phoenix-Mesa-Glendale, AZ $62,200 $1,451 $185,825 $264,224 $232,037 Philadelphia, PA $76,400 $1,783 $262,400 $324,545 $285,011 Minneapolis-St. Paul-Bloomington, MN-WI $82,300 $1,920 $219,000 $349,608 $307,021 San Diego-Carlsbad-San Marcos, CA $72,300 $1,687 $415,000 $307,128 $269,716 St. Louis, MO-IL $69,200 $1,615 $157,000 $293,959 $258,151 Nassau-Suffolk, NY $105,900 $2,471 $450,000 $449,860 $395,061 Tampa-St. Petersburg-Clearwater, FL $56,800 $1,325 $145,000 $241,284 $211,893 Baltimore-Towson, MD $85,600 $1,997 $255,000 $363,626 $319,331 Seattle-Bellevue-Everett, WA $86,700 $2,023 $355,000 $368,299 $323,435 Denver-Aurora-Broomfield, CO $77,800 $1,815 $254,000 $330,492 $290,233 Oakland-Fremont-Hayward, CA $89,200 $2,081 $473,750 $378,919 $332,761 Miami-Miami Beach-Kendall, FL $49,000 $1,143 $200,000 $208,150 $182,795 Pittsburgh, PA $65,100 $1,519 $154,380 $276,543 $242,856 Portland-Vancouver-Hillsboro, OR-WA $68,300 $1,594 $260,200 $290,136 $254,794 Cincinnati-Middletown, OH-KY-IN $68,700 $1,603 $153,975 $291,835 $256,286 San Antonio-New Braunfels, TX $61,300 $1,430 $169,000 $260,400 $228,680 Sacramento Arden-Arcade Roseville, CA $70,900 $1,654 $270,000 $301,181 $264,493 Newark-Union, NJ-PA $90,100 $2,102 $380,000 $382,742 $336,119 Kansas City, MO-KS $71,200 $1,661 $148,756 $302,455 $265,612 Fort Worth-Arlington, TX $65,500 $1,528 $166,607 $278,242 $244,348 Orlando-Kissimmee-Sanford, FL $58,500 $1,365 $155,000 $248,506 $218,235 Cleveland-Elyria-Mentor, OH $63,400 $1,479 $131,800 $269,321 $236,514 Las Vegas-Paradise, NV $63,100 $1,472 $167,500 $268,047 $235,395 Boston-Quincy, MA $88,000 $2,053 $390,000 $373,821 $328,284 San Jose-Sunnyvale-Santa Clara, CA $101,300 $2,364 $639,000 $430,319 $377,900 Columbus, OH $67,900 $1,584 $161,000 $288,437 $253,301 Detroit-Livonia-Dearborn, MI $52,300 $1,220 $90,000 $222,169 $195,105 Charlotte-Gastonia-Rock Hill, NC-SC $64,100 $1,496 $196,000 $272,295 $239,125 San Francisco-San Mateo-Redwood City, CA $101,200 $2,361 $800,500 $429,894 $377,527 Sources: FFIEC for median family income data; CoreLogic HPI for median house price data; Freddie Mac for mortgage rate data. Notes: Price data are as of August Author calculations assume that the mortgage is a 30-year fixed-rate loan with a 20 percent down payment and that property tax and homeowner s insurance together are 1.75 percent of the property value. 4 Housing Finance Policy Center

9 Figure 3. MSAs by Affordability, Using 28 Percent DTI Sources: CoreLogic HPI for house price data; FFIEC for median family income data; Freddie Mac for mortgage rate data. Notes: Data are as of August This figure plots the ratio of the maximum affordable house price under the current median family income and the prevailing mortgage rate (4.46%) over the median house price. The maximum affordable price is computed using 28 percent front-end DTI for all MSAs. Nothaft and Kiefer s timely analysis of the impacts of rising prices and mortgage rates on MSA-level affordability is an important improvement over national averages, but the use of an across-the-board DTI ratio ignores a fundamental characteristic of housing markets: borrowers in some regions and MSAs are willing to pay more for housing than borrowers in other parts of the country. That is, in some areas, higher median DTIs are long-standing practice. Economists have written extensively about the reasons for this variation across places and have posited possible factors, including the depth of the job market, weather, and other amenities (Albouy 2011; Rosen 1974, 1979). Using MSA-Level DTI We need a way to measure different willingness to pay for housing across places. As a reference period, we rely on data from 2000 to 2003 to calculate DTIs from median house prices and family incomes across the 37 largest MSAs. Higher DTI ratios suggest that a median-income family is willing to spend more than the national average on a median-price house, thus helping capture variations in willingness to pay for housing. We chose 2000 to 2003 as our reference period because it represents a period of relatively rational housing prices it falls between the 1999/2000 post-technology-bubble recession and the 2004/2006 subprime bubble. (We used data from 2000 to 2004 as an alternative measure, with a small effect on the The Impact of Mortgage Rate Increases on Housing Affordability 5

10 results.) We calculate the prevailing DTI using the same assumptions as in our national calculation (20 percent down payment, 30-year fixed-rate mortgage at the prevailing interest rate, property tax and homeowner s insurance at 1.75 percent of the home value). Using the aforementioned methodology, we find that the San Francisco, New York, Los Angeles, and San Diego MSAs have DTIs above or around 40 percent (table 2), which is much higher than the 28 percent standard. Meanwhile, many MSAs exhibit DTIs below 28 percent. For example, the DTI is 20 percent in Chicago, 18 percent in Atlanta, and 20 percent in Washington, DC, for the reference period. We then apply the MSA-level DTIs to our calculation of the maximum house price that a household earning the median income could sustain, given prevailing mortgage rates. We compare this maximum affordable house price with current median home prices. As shown in table 2, notoriously expensive areas like the New York metropolitan area appear to be severely unaffordable under the 28 percent DTI ratio standard; however, with the MSA-specific DTI adjustment, the picture does not seem so dire. 6 Housing Finance Policy Center

11 Table 2. Housing Affordability by MSA, Using MSA-Level DTI Median family income Monthly funds for housing Median house sale price Max affordable price under 4.46% Max affordable price under 6.0% Metropolitan division DTI New York-White Plains-Wayne, NY-NJ $66, % $2,223 $500,000 $404,706 $355,407 Los Angeles-Long Beach-Glendale, CA $61, % $2,034 $430,500 $370,242 $325,142 Chicago-Joliet-Naperville, IL $73, % $1,226 $200,000 $223,218 $196,027 Houston-Sugar Land-Baytown, TX $66, % $1,055 $191,250 $192,141 $168,735 Atlanta-Sandy Springs-Marietta, GA $66, % $987 $185,000 $179,723 $157,830 Washington-Arlington-Alexandria, DC-VA- MD-WV $105, % $1,745 $360,100 $317,613 $278,923 Dallas-Plano-Irving, TX $69, % $1,046 $206,899 $190,482 $167,278 Riverside-San Bernardino-Ontario, CA $62, % $1,537 $245,000 $279,895 $245,800 Phoenix-Mesa-Glendale, AZ $62, % $1,019 $185,825 $185,563 $162,959 Philadelphia, PA $76, % $1,266 $262,400 $230,493 $202,416 Minneapolis-St. Paul-Bloomington, MN-WI $82, % $1,285 $219,000 $233,976 $205,475 San Diego-Carlsbad-San Marcos, CA $72, % $2,479 $415,000 $451,334 $396,356 St. Louis, MO-IL $69, % $963 $157,000 $175,376 $154,013 Nassau-Suffolk, NY $105, % $2,460 $450,000 $447,849 $393,295 Tampa-St. Petersburg-Clearwater, FL $56, % $912 $145,000 $166,078 $145,847 Baltimore-Towson, MD $85, % $1,376 $255,000 $250,532 $220,013 Seattle-Bellevue-Everett, WA $86, % $1,790 $355,000 $325,840 $286,148 Denver-Aurora-Broomfield, CO $77, % $1,551 $254,000 $282,286 $247,900 Oakland-Fremont-Hayward, CA $89, % $2,913 $473,750 $530,337 $465,735 Miami-Miami Beach-Kendall, FL $49, % $1,008 $200,000 $183,585 $161,221 Pittsburgh, PA $65, % $949 $154,380 $172,769 $151,724 Portland-Vancouver-Hillsboro, OR-WA $68, % $1,292 $260,200 $235,268 $206,609 Cincinnati-Middletown, OH-KY-IN $68, % $935 $153,975 $170,191 $149,459 San Antonio-New Braunfels, TX $61, % $994 $169,000 $181,025 $158,974 Sacramento Arden-Arcade Roseville, CA $70, % $1,797 $270,000 $327,159 $287,306 Newark-Union, NJ-PA $90, % $1,975 $380,000 $359,576 $315,775 Kansas City, MO-KS $71, % $995 $148,756 $181,089 $159,030 Fort Worth-Arlington, TX $65, % $897 $166,607 $163,225 $143,342 Orlando-Kissimmee-Sanford, FL $58, % $951 $155,000 $173,100 $152,014 Cleveland-Elyria-Mentor, OH $63, % $910 $131,800 $165,730 $145,542 Las Vegas-Paradise, NV $63, % $1,197 $167,500 $217,859 $191,321 Boston-Quincy, MA $88, % $2,191 $390,000 $398,838 $350,254 San Jose-Sunnyvale-Santa Clara, CA $101, % $3,268 $639,000 $594,913 $522,444 Columbus, OH $67, % $988 $161,000 $179,861 $157,951 Detroit-Livonia-Dearborn, MI $52, % $647 $90,000 $117,822 $103,470 Charlotte-Gastonia-Rock Hill, NC-SC $64, % $1,001 $196,000 $182,277 $160,073 San Francisco-San Mateo-Redwood City, CA $101, % $4,296 $800,500 $782,076 $686,808 Sources: FFIEC for median family income data; CoreLogic HPI for median house price data; Freddie Mac for mortgage rate data. Notes: Price data are as of August Author calculations assume that the mortgage is a 30-year fixed-rate loan with a 20 percent down payment and that property tax and homeowner s insurance together are 1.75 percent of the property value. The DTI ratio is computed using median housing price, prevalent mortgage rate, and median family income. Figure 4 visualizes the numbers in table 2 by ranking the MSAs by affordability using this revised method. With the DTI adjustment, in the New York metropolitan area the maximum price affordable to a family earning the median household income is 81 percent of the median home price as of August Without adjusting for MSA-level DTI, the maximum affordable price is 56 percent of the median house price. Thus, New York is still unaffordable, but less so. The DC metropolitan area is another good example of the different picture of housing affordability that results from adjusting for MSA-level DTI. The Impact of Mortgage Rate Increases on Housing Affordability 7

12 Using the 28 percent DTI standard, DC appears quite affordable (see table 1): its maximum affordable price is $449,860, which is 25 percent higher than the August 2013 median home price of $360,100. Under the MSA-specific DTI, however, the maximum affordable price is $317,613, which is 12 percent lower than the median home price. Using the localized DTI, the DC area moves from affordable to unaffordable. Figure 4. MSAs by Affordability, Using MSA-Level DTI Sources: CoreLogic HPI for house price data; FFIEC for median family income data; Freddie Mac for mortgage rate data. Notes: Data are as of August This figure plots the ratio of the maximum affordable house price under the current median family income and the prevailing mortgage rate (4.46%) over the median house price. The maximum affordable price is computed using MSA-level DTI from data. 8 Housing Finance Policy Center

13 Incorporating Variation in LTV across MSAs Another important aspect of affordability is the loan-to-value (LTV) ratio. We have thus far assumed that a typical borrower pays 20 percent down, resulting in an LTV of 80. But does the LTV vary across MSAs and over time? In this section we incorporate the impact of LTV on affordability. We recognize that while a higher LTV may reduce affordability because it implies higher principal and interest payments, and thus higher DTI, it may enhance access in the sense that potential buyers need smaller down payments. The latter is an issue of wealth, rather than income, and is a subject for future research. To factor in the impact of LTV, we recomputed the MSA-level DTI using the MSAlevel LTV instead of 80 percent for all. We use CoreLogic servicing data 3 for home purchase loans to compute the (value-weighted) mean LTV at the MSA level and regenerate the MSA-level DTI. We then use the LTV-adjusted DTI to compute current affordability, taking into consideration current LTV. We show how incorporating LTV affects our findings, first on national affordability and then on affordability by MSA. Nationwide, the mean LTV has changed from 80 percent during to 85 percent in the first seven months of 2013 (figure 5). 4 This captures the fact that the Federal Housing Administration (FHA) has had a much larger footprint since the financial crisis; FHA loans on average have low down payments. The green line in figure 2 (see page 3) depicts the maximum affordable price using the nationwide mean LTV over time (instead of using 80%); other assumptions remain unchanged. We can see that while the LTV-adjusted maximum affordable price overlaps with the maximum affordable price calculated using 80 percent LTV very closely during , the LTV-adjusted maximum affordable price is strictly below the non-adjusted one after August 2006, when the mean LTV turned above 80 percent. The average reduction in the maximum affordable price is $12,000 after August To summarize, the higher LTV creates a higher burden, lowering the feasible mortgage amount and hence lowering the borrower s ability to afford the loan on a house of a given price. The Impact of Mortgage Rate Increases on Housing Affordability 9

14 Figure 5. Mean LTV for Purchase Loans, % 88% 86% 84% 82% 80% 78% 76% 74% Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Source: CoreLogic prime and subprime servicing data. Notes: This figure plots the (value-weighted) average LTV for purchase loans originated from 2000 to According to CoreLogic, its data cover 78 percent of all residential mortgages. Table 3 reports results of the analysis of affordability by MSA incorporating the effect of LTV. Several observations stand out. First, LTV varied slightly across MSAs during San Francisco had the lowest LTV, at 65.7 percent, while San Antonio had the highest, at 87.5 percent. Second, many MSAs experienced an increase in mean LTV from to For example, Boston had an increase of 10 percentage points, from a mean of 71 percent in to 81 percent in Third, the level of LTV affects the computed DTI based on data. For example, New York had a mean LTV of 74.2 percent, resulting in a DTI of 38.1 percent, slightly lower than the DTI of 40.4 percent under an acrossthe-board 80 percent LTV. Figure 6 ranks the MSAs by their affordability using this MSA-specific DTI and LTV methodology. 10 Housing Finance Policy Center

15 Table 3. Housing Affordability by MSA, Using MSA-Adjusted DTI and LTV LTV 2013 LTV Median family income DTI Monthly funds for housing Median house sale price Max affordable price under 4.46% Max affordable price under 6.0% Metropolitan division New York-White Plains-Wayne, NY-NJ 74.2% 74.7% $66, % $2,098 $500,000 $401,416 $353,310 Los Angeles-Long Beach-Glendale, CA 77.8% 77.6% $61, % $1,990 $430,500 $370,372 $325,577 Chicago-Joliet- Naperville, IL 79.8% 82.8% $73, % $1,224 $200,000 $217,191 $190,522 Houston-Sugar Land- Baytown, TX 83.4% 83.8% $66, % $1,090 $191,250 $191,783 $168,170 Atlanta-Sandy Springs- Marietta, GA 83.6% 86.6% $66, % $1,021 $185,000 $175,395 $153,645 Washington-Arlington- Alexandria, DC-VA- MD-WV 81.5% 86.3% $105, % $1,769 $360,100 $304,552 $266,812 Dallas-Plano-Irving, TX 84.7% 85.2% $69, % $1,094 $206,899 $190,014 $166,531 Riverside-San Bernardino-Ontario, CA 82.6% 86.0% $62, % $1,577 $245,000 $272,048 $238,362 Phoenix-Mesa- Glendale, AZ 83.0% 86.3% $62, % $1,049 $185,825 $180,553 $158,178 Philadelphia, PA 79.5% 83.9% $76, % $1,260 $262,400 $221,334 $194,074 Minneapolis-St. Paul- Bloomington, MN-WI 78.7% 88.1% $82, % $1,269 $219,000 $214,920 $188,163 San Diego-Carlsbad- San Marcos, CA 73.5% 81.4% $72, % $2,322 $415,000 $417,615 $366,545 St. Louis, MO-IL 81.2% 87.4% $69, % $975 $157,000 $166,088 $145,446 Nassau-Suffolk, NY 73.0% 78.8% $105, % $2,293 $450,000 $422,323 $371,066 Tampa-St. Petersburg- Clearwater, FL 81.6% 86.3% $56, % $927 $145,000 $159,543 $139,775 Baltimore-Towson, MD 82.9% 87.8% $85, % $1,415 $255,000 $240,403 $210,500 Seattle-Bellevue- Everett, WA 77.9% 82.0% $86, % $1,753 $355,000 $313,242 $274,862 Denver-Aurora- Broomfield, CO 81.1% 85.0% $77, % $1,566 $254,000 $272,615 $238,943 Oakland-Fremont- Hayward, CA 70.3% 77.7% $89, % $2,639 $473,750 $490,757 $431,382 Miami-Miami Beach- Kendall, FL 82.7% 79.4% $49, % $1,034 $200,000 $189,326 $166,303 Pittsburgh, PA 82.9% 87.3% $65, % $976 $154,380 $166,450 $145,771 Portland-Vancouver- Hillsboro, OR-WA 79.0% 84.7% $68, % $1,280 $260,200 $223,276 $195,720 Cincinnati-Middletown, OH-KY-IN 83.5% 87.4% $68, % $967 $153,975 $164,776 $144,298 San Antonio-New Braunfels, TX 87.5% 91.0% $61, % $1,066 $169,000 $176,260 $154,165 Sacramento Arden- Arcade Roseville, CA 77.7% 85.0% $70, % $1,757 $270,000 $305,949 $268,166 Newark-Union, NJ-PA 75.8% 79.9% $90, % $1,894 $380,000 $345,247 $303,205 Kansas City, MO-KS 83.8% 89.3% $71, % $1,031 $148,756 $172,980 $151,387 Fort Worth-Arlington, TX 86.4% 87.8% $65, % $952 $166,607 $161,721 $141,602 Orlando-Kissimmee- Sanford, FL 81.8% 88.1% $58, % $967 $155,000 $163,911 $143,509 Cleveland-Elyria- Mentor, OH 82.3% 88.2% $63, % $931 $131,800 $157,491 $137,880 The Impact of Mortgage Rate Increases on Housing Affordability 11

16 Table 3 (continued) LTV 2013 LTV Median family income DTI Monthly funds for housing Median house sale price Max affordable price under 4.46% Max affordable price under 6.0% Metropolitan division Las Vegas-Paradise, NV 83.7% 87.2% $63, % $1,239 $167,500 $211,550 $185,273 Boston-Quincy, MA 71.1% 81.6% $88, % $2,003 $390,000 $359,407 $315,428 San Jose-Sunnyvale- Santa Clara, CA 66.5% 74.1% $101, % $2,839 $639,000 $546,150 $480,824 Columbus, OH 85.7% 87.7% $67, % $1,043 $161,000 $177,268 $155,222 Detroit-Livonia- Dearborn, MI 84.0% 87.1% $52, % $672 $90,000 $114,867 $100,602 Charlotte-Gastonia- Rock Hill, NC-SC 83.6% 86.0% $64, % $1,036 $196,000 $178,688 $156,560 San Francisco-San Mateo-Redwood City, CA 65.7% 71.8% $101, % $3,701 $800,500 $728,303 $641,874 Sources: FFIEC for median family income data; CoreLogic HPI for median housing price data; Freddie Mac for mortgage rate data. Notes: Price data are as of August Author calculations assume that the mortgage is a 30-year fixed-rate loan and that property tax and homeowner s insurance together are 1.75 percent of the property value. The DTI is computed using median housing price, prevalent mortgage rate, median income, and mean LTV (instead of an across-theboard 80% LTV). The 2013 maximum affordable price is computed using MSA-level DTI and 2013 LTV. Figure 6. MSAs by Affordability, Using MSA-Level DTI and LTV Sources: CoreLogic HPI for house price data; FFIEC for median family income data; Freddie Mac for mortgage rate data. Notes: Data are as of August This figure plots the ratio that is the maximum affordable house price under the current median family income and the prevailing mortgage rate (4.46%) over the median house price. The maximum affordable price is computed using MSA-level DTI from data and 2013 MSA-level LTV (instead of an across-the-board 80% LTV). 12 Housing Finance Policy Center

17 The increase in LTV from to 2013 for most MSAs might be expected to result in lower affordability, and this is what we find. Comparing tables 3 and 2 and figures 6 and 4, the maximum affordable price is lower in general using the MSA-specific LTV as well as DTI; therefore, more MSAs become unaffordable. For example, while Boston had a maximum affordable price that is 2 percent higher than the median sales price using an 80 percent LTV assumption, its maximum affordable price becomes 8 percent lower than the median sales price when adjusted for MSA-level LTV (which increased from 71 percent in to 81 percent in 2013). Overall, as of August 2013, only 18 the 37 largest MSAs are affordable, taking into account MSAspecific DTI and LTV. That is, in only 18 MSAs is the maximum affordable price above the median house price (the ratio of maximum affordable price to median house price is above 1 in figure 6). 5 The Impact of a Mortgage Rate Increase on Affordability Another purpose of this paper is to measure the impact of higher mortgage rates on affordability. We use our affordability measure adjusted for DTI and LTV. We then change the mortgage rate from the market rate of 4.46 percent as of August 2013, based on Freddie data, to 5 percent and 6 percent, and see how affordability changes. The nationwide maximum affordable prices for 5 and 6 percent mortgage rates are depicted in figure 2 (see page 3) by the two Xs on the far right. We see that higher interest rates bring down the maximum affordable price significantly. In the case of a 6 percent rate, using an LTV of 84.4 percent (the average of 2013 purchase loans), the maximum affordable price is $218,292, only 4.4 percent higher than the median home sales of $209,000 at the end of August The maximum affordable prices for MSAs are reported in the last two columns of tables 2 and 3. We find that while typical families in 18 of the 37 largest MSAs are still able to afford the median home price at the 4.46 percent rate, families in just 4 MSAs will be able to afford the median home price under the 6 percent scenario. 6 In summary, we find that MSAs have large differences in their residents willingness to pay for housing and in their down payment rate. Using MSA-specific DTI and LTV, we find that as of August 2013, slightly more than half the largest 37 MSAs are already unaffordable. If interest rates rise to 6.0 percent, only four are affordable. Our evidence is consistent with the Fed s recent decision not to taper off its purchase program in order to stem further interest rate increases amid a slow recovery. The Impact of Mortgage Rate Increases on Housing Affordability 13

18 Conclusion There are four major considerations in housing affordability: home prices, incomes, interest rates, and funds available for a down payment. This paper considers the first three. Given the continued increases expected in home prices, muted increases expected in incomes, and notwithstanding the Fed s commitment to stemming interest rate increases during the slow economic recovery, affordability will likely continue to deteriorate, albeit less drastically than in the first half of Housing Finance Policy Center

19 References Albouy, David Y Are Big Cities Bad Places to Live? Estimating Quality of Life across Metropolitan Areas. Working Paper Cambridge, MA: National Bureau of Economic Research. Nothaft, Frank E., and Leonard Kiefer June 2013 U.S. Economic & Housing Market Outlook: What Happens When Interest Rates Rise? McLean, VA: Freddie Mac. Parrott, Jim, and Mark Zandi Opening the Credit Box. New York and Washington, DC: Moody s Analytics and the Urban Institute. Rosen, Sherwin Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition. Journal of Political Economy 82: Wages-Based Indexes of Urban Quality of Life. In Current Issues in Urban Economics, edited by Peter M. Mieszkowski and Mahlon R. Straszheim. Baltimore, MD: Johns Hopkins University Press. The Impact of Mortgage Rate Increases on Housing Affordability 15

20 Notes 1 For its HAI, NAR classifies a typical home as the national median-priced single-family home; the typical family is defined as one earning the median family income as reported by the US Census; and the prevailing interest rate is the effective rate on loans closed on existing homes as reported by the Federal Housing Finance Agency. 2 The front-end DTI measures the relationship of housing-related obligations, namely principal and interest payments on a mortgage, and payments for property taxes, homeowner s insurance, and, where applicable, mortgage insurance and homeowners association fees, to income. 3 These data are collected from the largest servicers in the United States and cover 78 percent of all residential mortgages ( 4 Our calculation of the mean LTV is consistent with what is reported in Parrott and Zandi (2013): The average purchase loan today has an LTV of 86% to 90%, compared with 75% to 80% prior to the bubble. 5 A potential downside of this method is that it uses a static DTI for an MSA while the MSA might have changed from to While this point is valid, we think our method provides an anchor to incorporate the MSA-inherent difference in a selfcontained way. Further work can be done to incorporate time-variant aspects systematically. The combination of national overall affordability and half of the largest MSAs being unaffordable stems largely from the fact that the national affordability calculation uses 28 percent as the DTI while the average DTI (obtained from data assuming LTV being 80 percent) across the largest 37 MSAs is 24.2 percent. Had we used 24.2 percent DTI to calculate current affordability, the maximum affordable price would have been $223,860, only 7.1 percent higher than the August 2013 median home price of $209,000; using 28 percent DTI leads to a maximum affordable price of $259,000, 23.9 percent higher than the median home price of $209, Again the seeming inconsistency between the nation overall being affordable and the finding that only 4 of the largest 37 MSAs are affordable at a 6 percent mortgage rate stems largely from the fact that the national affordability calculation uses 28 percent as the DTI across the years while the average DTI (obtained from ) across the largest 37 MSAs is 23.8 percent. Had we used 23.8 percent DTI (obtained from data including LTV) and 2013 LTV to calculate the current affordability, the maximum affordable price at 6 percent would have been $187,107, lower than the $209,000 August 2013 median home price. 16 Housing Finance Policy Center