Summary: One silver lining about the current state of the real estate market is that, for homebuyers with good credit and savings for a down payment, homes are more affordable than they’ve been in the past 35 years. However, affordability is not the only factor that impacts homeownership rates—we must also consider a prospective buyer’s access to mortgage credit. The research team at Zillow constructed indexes for home affordability and mortgage accessibility dating back to 1975. While affordability is at its highest level seen in the data, current mortgage accessibility is significantly lower than during the housing peak but still slightly stronger than historical levels. 

With home prices still falling and mortgage rates remaining near historic lows, optimists are reframing the picture of continuing home declines by pointing out that homes are more affordable than they’ve been in years. And this is, without a doubt, true. Of course, what’s changed considerably is accessibility to mortgage credit. In order to understand these two components of the housing market—affordability and accessibility, let’s look at each independently.

Our first step was to construct a time series that shows what percentage of gross income is consumed by mortgage expenses (Figure 1). We used the US median household income, the median value of a US home, the average rate on a 30-year fixed-rate mortgage and assumed a 20% down payment as inputs in this time series. As the line gets lower, mortgage payments take up a smaller share of one’s income, and buying a home becomes a more attractive decision.

First, the good news: today’s median home buyer can expect to pay about 17% of his monthly gross income on his mortgage, compared to a 25% average since 1975. Moreover, homes are more affordable now than they’ve been in 35 years.

Interestingly enough, affordability during the recent housing boom wasn’t that far from historical norms.  It looks especially modest compared to the early 1980s when mortgage payments spiked to near 45% of gross income due to mortgage rates hitting 18%, driving home the point that mortgage rates need to be evaluated alongside home values when making a buying decision (as discussed in this Zillow Research brief in February).

Using this mortgage-as-a-percentage-of-income data in Figure 1, we created an Affordability Index (see Figure 2) by setting the value at 100 in 1975, our first year of data, and tracking subsequent changes.  As a mortgage for the median home buyer becomes a smaller share of his median income, the Affordability Index goes up. Figure 2 also overlays the historical percentage of homeownership.  Comparing the two data series in Figure 2, we might expect them to have a direct relationship—when affordability increases, homeownership should increase, and vice versa. Of course, we know from the current housing recession that this is not always the case (when home values fell along with sales volume and homeownership rates).

One reason behind this phenomenon is that housing markets don’t behave like traditional asset markets where prices are negatively correlated with sales volume.  In housing market booms, both prices and sales increase and, during busts, both decrease.   But during the recent housing boom, another factor became much more prominent in driving up homeownership rates even while housing affordability was declining.  This factor was easy access to mortgage credit.

One of the chief factors that affected access to credit during the most recent housing boom was the availability of subprime mortgages. According to research done by the Federal Reserve, almost 25% of all mortgages originated in 2006 and 14% of all mortgages outstanding in 2007 were considered subprime (which the Fed defined as loans made to borrowers with FICO scores below 620-660 and/or unable to make a 20% down payment). But these subprime mortgages weren’t the only factor affecting accessibility.  The full context of mortgage accessibility has to consider not just subprime mortgages but also down payment requirements and the portion of the market backed by mortgages guaranteed by the Federal Housing Administration (FHA).  FHA loans are an important component to mortgage availability because they have a minimum down payment requirement of 3.5%, thus lowering the down-payment hurdle significantly.

To gain some perspective on accessibility, we created a Mortgage Accessibility Index by looking at the share of the subprime market and median down payments. Like the Affordability Index, our base year was 1975. When the “hurdle” for mortgages dropped (growth of the subprime market, lower down payment requirements), that drove the Mortgage Accessibility Index up, meaning that it was easier for homebuyers to get a mortgage.  This index is shown in Figure 3.  While we all know that lending standards relaxed during the housing boom, totaling up the cumulative impact of various looser standards and viewing them in the historical context is still somewhat awing even afterwards.  Compare 2006 to 1975: in 2006, the median down payment on non-FHA loans dropped to 4% and subprime mortgages were close to 25% of all originations; in 1975 with down payments of 20% and subprime mortgages estimated to be less than 2% of all originations.

The incredible amplification we see in the Mortgage Accessibility Index completely overshadows the changes in the Affordability Index over time. Despite the fact that actual affordability was likely lower for people who benefited from the huge increase in accessibly (i.e. lower down payments meant higher principal balances, lower credit scores meant higher interest rates, and sometimes both), increased access to credit was a major driver in the rise in homeownership during the recent boom.

And with the housing bust, we have now seen a reset in lending standards and, thus, access to mortgage credit.  First, subprime mortgages have all but disappeared.  In a Zillow Research Brief from October, we found that applicants with FICO scores under 620 were virtually unable to get loans at any rate, thus being effectively excluded from the home-buying market.  And those with FICO scores below 620 represent almost a third of the population.

Second, down payment requirements have gone back up to the 20% level that has prevailed for much of the history of the modern mortgage market (see the recent WSJ analysis of this trend using Zillow data).  This higher bar means a lot for a prospective home buyer looking at that prospective median home (priced at $172,200 in January 2011).  The difference between a 10% and 20% down payment means she now has to save up another $17,220 in addition to any closing costs.

So, homes are now more affordable than at any time in recent memory.  But, at the same time, access to credit is much lower than it was during the housing boom.  That said, though, mortgage accessibility is still much better than it has been throughout much of the history shown in Figure 3 (our index has it currently at 125, shown by the green line).  In fact, without the substantially ramped up participation of FHA in the mortgage markets, accessibility would be much worse currently (index score of 78 shown by the red line in Figure 3).

It’s important to remember a few things.  First, people’s visceral perception that it’s harder to get a mortgage now than it was just a few years ago is correct.  Second, while mortgage accessibility seems tight now, it’s about normal relative to historical levels.  Third, courtesy of an unprecedented housing collapse that brought down home values and a wrenching economic recession that brought down interest rates, home affordability has never been better.

If you’re part of the population that has kept strong credit and still has significant savings after the recent economic downturn, then increased affordability represents a real opportunity. On the other hand, for people who’ve lost savings, are in a negative equity position with their home, or have seen their credit score drop (perhaps due to a foreclosure), it can be disheartening to see such great affordability when it is now just out of reach because of changes in mortgage accessibility.

Photo: Rory Finneren, Flickr