Cutting Edge Insights
with Dr. Lee

Coming to Terms with Affordability

Q:  What is Affordable?

A:  I ate a banana for breakfast. That was affordable.

Q:  No…what does affordable mean?

A:  Well, according to dictionary.com, as an adjective it means “believed to be within one’s financial means.”

Q:  How would you define it relative to housing?

A:  Hmmm…housing is an expense that never goes away. Maybe you don’t have a mortgage payment, but you still have expenses associated with living. Utilities. Maintenance. Taxes. Insurance. Etc. Perhaps my best definition of affordable relative to housing would be, “that which consumes fewer financial resources than those available for consumption.”  In other words, under budget. It’s always nice to have a little extra room in the budget. Because “If your outgo exceeds your income, your upkeep will be your downfall.”

The fact that housing prices have been increasing since the start of the pandemic is not news. Many sources highlight that the trend shows no signs of slowing down.

Mortgage rates, on the other hand, are starting to inch up.

I wonder if there will be an inflection point in the future.

Let’s do a deep dive into commonly held beliefs about affordability. Let’s begin by reviewing current facts.

  1. According to census.gov, the median household income was $67,521 in 2020, the most recent year for which statistics are available according to that source.
  2. According to bankrate.com, the debt to income ratio (with respect to monthly expenses) to qualify for a mortgage is 28% (and all debts not to exceed 36%).
  3. According to CNN Business, the median home price was $346,900 in 2021.
  4. According to FOX Business, the 30-year fixed mortgage rate was 3.75% as of 2/10/22. (This represents a recent pullback of 0.125% after a few instances of increase in the last few months.)

OK. Now that we have the facts according to our assumed-reputable sources, doing the math is easy:

28% of $67,521 is $18,905.88. That divided by 12 is $1,575.49.

$1,575.49 is the monthly principal and interest payment (at 3.75%) of a 30-year loan on $340,193.

$340,193 represents either:

1) a home purchase of $350,714 with 3% down payment or

2) a home purchase of $425,241.25 with a 20% down payment.

Although the latter scenario is numerically possible, the statistics show that it is not probable.

We will assume that this hypothetical family’s other debt does not consume more than the 8 additional percentage points of the total debt to income ratio in order not to exceed the ceiling of 36%. That would equate to $450.14 per month. This may be tough, however: most car payments are in excess of this.

Q:  What about property taxes and insurance? They are sometimes bundled into the payment.

A:  They are considered expenses, not debt, no matter how they are paid. But if you are a contrarian like me, you consider property taxes to be a debt that never goes away.

The good people in charge at Fannie Mae and Freddie Mac already consider you to spend a decent chunk of your median income of $67,521 on income taxes and general living expenses (See my previous article, “What Really is Your Biggest Expense?” here). Taking all that into account (there are too many variables and thus situations to really examine each one), you may assume that there isn’t a great deal of money remaining at the end of the month for a family with the circumstances described above.

Yet conventional wisdom indicates that a home from $350K to $425K would be “affordable” to this hypothetical family.

Q:  What about a maintenance reserve? Most roofs don’t cost less than $15-$20K these days. What about utilities? I know you mentioned property taxes and insurance above, but what if the AC condensing unit fails?

A:  Now you’re getting the picture.

It seems to me that our system was set up and put in place to highlight the minimum necessary circumstances to “get by.”  There isn’t much room or margin for error. There isn’t a whole lot of forgiveness when one purchases a home for $350-425K and one’s income is $67.5K. Where are the retirement savings? Where is the vacation fund? The rainy day fund?

Q:  Well, they could purchase a less expensive home.

A:  The figures cited above were median home prices and median incomes.

Q: They could rent.

A: That’s often a very viable alternative. Renting may be cheaper than buying. However, renting is not as likely to take our hypothetical family closer to “achieving the American Dream,” although individual mileage may vary.

Jessica Stillman in “These Are the 3 Most Toxic Pieces of Common Financial Advice, a New Survey Says” proposes that “Owning a home is a great way to build wealth, if you can afford it.” And I disagree. Owning a home doesn’t help you build wealth. You and your family have to live somewhere – and a home, whether you rent it or own it, takes money out of your pocket. It doesn’t put money in your pocket. But I’ll acquiesce to this: home ownership is one of the more predictive attributes of wealth-building propensity in those that both own homes and build wealth.

Q:  Oh. What else can we do?

A:  The term “affordable housing”  has never been a favorite of mine. This may simply be one of my own idiosyncrasies, or some of my readers may share my reservations. When I hear the term, my mind automatically goes to “government subsidized” or “Section 8” or something of that nature.

Not that the government should subsidize housing. Not that it shouldn’t. That is a topic for a different author and a different educational focus.

Some have used the term “workforce housing” to convey a development effort in which new, simple, functional homes are designed and built. These homes may not have 9-foot ceilings, extra or unnecessary rooms, granite countertops, or a backyard pool. Heck, they may not have much of a backyard at all. But they have a yard.

The National Association of Realtors (NAR) defines workforce housing as “housing that is affordable to workers and close to their jobs.”

NAR goes on to reference the Urban Land Institute’s definition of workforce housing, which is “housing that is affordable to households earning 60 to 120 percent of the area median income.” Workforce housing usually does not consume more than 30-40 percent of individual income.

30-40 percent would seem to exceed the mortgage approval numbers described earlier (and therefore be less conservative); however, I can accept this if all housing costs are included (mortgage payment, taxes, insurance, utilities, maintenance reserve).

I have a theory. It’s not a “rocket science,” “hold my beer please,” “get out your pen and paper,” “mark my words,” “groundbreaking,” or “earth-shattering” concept. It is simple, logical, and obvious from the numbers cited above.

My theory is that we have allowed housing costs to spiral out of control in this country. As always, there are various reasons. Some of which we can control; others we cannot.

I started feeling this way in 2016 after reading architect Sarah Susanka’s “The Not So Big House” and realizing that there is so much more we can control about housing design (and therefore, cost) than that which we allow ourselves to control.

Q:  If we do take responsibility for as many factors as we can control, what can we accomplish?

A: The answer to that question is precisely why, even though I don’t have an engineering license or degree, I love being a value engineer. (See my previous article, “Why I love Building Science and Value Engineering” here).

Stay tuned. The real answer to this question is on the way. Along with plenty more information.

Should we continue to accept things as they are or should we try to improve them? In what ways could improvements be possible?

I invite you to contact me at Lee@DrLeeNewton.com with any and all questions or feedback.

Until next time,

Dr. Lee Newton

How A Doctor Learned To Develop Real Estate

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Coming to Terms with Affordability

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