Housing Affordability: Three Levers and How Each Moves the Payment

When people say housing has become less affordable, they usually mean the monthly payment has grown faster than income. Three things combine to produce that payment: the price of the home, the interest rate on the loan, and the household's income. Seeing how each one works makes it easier to understand headlines and your own options.

Key takeaways

• Housing affordability depends on three things at once, which are the price of the home, the household's income and the interest rate on the loan.
• In a hypothetical $350,000 loan, a payment of about $1,671 at 4 percent rises to about $2,329 at 7 percent, a 39 percent increase.
• To get back to the original payment, the rate would need to fall, the loan would need to be about 28 percent smaller, or income would need to be about 39 percent higher to keep the same share of income.
• Lenders look at debt-to-income ratios, so a payment that rises faster than income can change what a household qualifies to borrow.
• These examples cover principal and interest only, and taxes, insurance and maintenance can add substantially to the total.

A starting example

Take a hypothetical household with $90,000 in gross annual income, or $7,500 a month. It borrows $350,000 on a 30-year fixed-rate mortgage. To keep things simple, this uses principal and interest only.

• At a 4 percent rate, the payment is about $1,671, or roughly 22 percent of gross monthly income.
• At a 7 percent rate, the payment is about $2,329, or roughly 31 percent of gross monthly income.

Nothing about the household changed except the rate, yet the payment is about 39 percent higher and takes a much bigger bite out of income.

What it would take to go back

Suppose the household wanted the payment to return to about $1,671. There are three ways to get there, and they can be combined.

1. The rate comes down. Back to 4 percent restores the payment on the same loan.
2. The loan gets smaller. At 7 percent, a loan of about $251,000 produces a payment close to $1,671. That is roughly 28 percent less than $350,000, through a lower purchase price, a larger down payment, or both.
3. Income goes up. To keep the payment at about 22 percent of gross income while paying $2,329, monthly income would need to be about $10,450, or roughly $125,000 a year. That is about 39 percent more than $90,000.

Most households would not rely on a single lever. A moderate drop in rate, a somewhat smaller purchase and some income growth could add up to the same result, which is why discussions of affordability so often describe combinations.

Why the ratio matters to lenders

The Consumer Financial Protection Bureau explains that a debt-to-income ratio divides total monthly debt payments by gross monthly income, and that lenders use it to judge whether a borrower can manage additional payments. A payment that grows faster than income pushes the ratio up, and that can change both what a household is approved to borrow and how comfortable the budget feels.

The CFPB also notes that creditors set their own guidelines, so a ratio acceptable to one lender may not be acceptable to another.

What the example leaves out

The figures above include only principal and interest. A real housing payment typically adds property taxes, homeowners insurance, and sometimes mortgage insurance or association fees. Maintenance and utilities come on top of that. All of these vary by location and can change from year to year.

The example also treats each lever as if it moves on its own. In practice they interact. Rates can influence prices, prices can influence what buyers are willing to pay, and local incomes and inventory differ from one area to the next. A national headline rarely describes any one town.

Using the levers on your own numbers

A household thinking about a purchase might work through a few questions:

• What share of gross income would the full housing payment represent, including taxes and insurance?
• How would that share change if the rate were a point higher or lower?
• How much smaller would a loan need to be to keep the payment where it is comfortable?
• What would a larger down payment, a different price range or a different location do to the numbers?

Running a few scenarios turns a vague sense of "unaffordable" into specific figures, and it shows which lever is doing the most work in your situation.

Common questions

What makes a home affordable?

It depends on how the monthly cost compares with income. The main inputs are the price of the home, the down payment, the interest rate and the household's income, along with taxes, insurance and other housing costs.

If rates rise, do prices have to fall to keep payments the same?

Not necessarily. For a household, a higher rate can be offset by a smaller loan, a larger down payment, higher income, or a combination. Prices in the broader market move for many reasons, so they do not move one for one with rates.

What is a debt-to-income ratio?

It is total monthly debt payments divided by gross monthly income. The Consumer Financial Protection Bureau explains that lenders use it to judge whether a borrower can manage additional payments.

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