February 2008

Housing Affordability Improves as Prices and Rates Decline
By Robert A. Kleinhenz, Ph.D. Deputy Chief Economist


Affordability Low Despite Market Slowdown

Decreases in the median price and declining mortgage rates during the fourth quarter of 2007 dramatically improved affordability in California for the first time in two years. At $483,730, the statewide median price fell by a record margin of 14.9 percent or $84,400 compared to the third quarter median of $568,130. The medianprice was nearly $80,000 lower than the median of $561,430 from the fourth quarter of 2006, corresponding to a record-setting 13.8 percent year-to-year decrease. Nearly all areas of the state experienced large price declines, as tighter underwriting standards and the liquidity crunch dramatically reduced the pool of qualified buyers who could obtain a loan.

Dramatically lower prices have contributed to large improvements in affordability in recent months. The C.A.R. Housing Affordability Index for First-Time Buyers (HAI-FTB) measures the share of all households that can afford the entry-level home. At 85 percent of the overall median, the price of an entry-level home in the fourth quarter was $411,170. Assuming a 10 percent down payment and a 1-year adjustable rate mortgage of 6.21 percent, the monthly payment (including taxes and insurance) was $2,740. With a 40 percent qualifying ratio the minimum income required for such a home was $82,200, considerably below the levels of recent quarters whenthe minimum income approached $100,000.

Given these calculations, the HAI-FTB was 33 in the fourth quarter of 2007, meaning that 1 in 3 households could afford the entry-level home in California. The index rose by an impressive 9 points from 24 in the third quarter, and also rose 8 points compared to 25 a year ago. Affordability last stood at 33 percent was in the first quarter of 2005.

Part of these gains came from decreases in mortgage rates. The one-year effective adjustable rate was 6.21 percent in the fourth quarter, down more than a third of a percent from 6.56 percent a quarter earlier, and somewhat below the 6.36 percent rate of a year earlier.

No region of the state came close to the national affordability reading of 65, although the High Desert and Sacramento County both had affordability readings over 50. Monterey and Santa Barbara Counties were the least affordable, with just one in five households able to afford the entry-level home in those parts of the state.
 
In a sense, these are only "paper-gains" in affordability. The index does not account for changes in underwriting standards. Because of tighter underwriting standards, even some well-qualified buyers have been unable to obtain financing on home loans. Nor do the HAI-FTB calculations take the current liquidity crunch into consideration. Would-be buyers seeking homes over $500,000 frequently have been left empty-handed as lenders have been unable to fund their loans because of the liquidity crunch. Those who successfully obtain jumbo loans pay a premium, with the spread between jumbo and conforming rates approaching two percent. So while affordability appears to have improved, it remains to be seen whether it will trigger an uptick inactivity over the near future.

To learn more about our Trends Newsletter, please contact the Research & Economics Department at  research@car.org or (213) 739-8352.