How much house can you afford? A recent report shows it depends on where you live.
The National Association of Realtors (NAR) tracks home prices across the country and formulated a home buyer’s needed income level to afford the average single family home in various US cities.
Income requirements vary drastically based on geographic location.
A family in Topeka, Kansas putting 20% down needs only to make $19,000 per year to buy the average home. The same family would need to make over $90,000 to buy a home in San Diego, California.
But these two locations are statistical outliers. Looking at the entire US, the average home price was $209,000 in the fourth quarter of 2014. The income needed to buy the average US home, according to the NAR, is about $38,000 per year.
Many families are finding it easier than they expected to break into their local housing market. Dropping rates and cooling home appreciation have helped average home buyers like few times in history.
NAR Report Underestimates Buying Power
Most home buyers can afford more house with less money than the NAR study suggests.
The report bases findings on conservative terms: the home payment is equal to just 25% of the buyer’s income. Even adding in property taxes and homeowners insurance, costs the NAR does not factor in, most borrowers can qualify for more.
Lenders can approve house payments up to 30-40% of a borrower’s income depending on other debts and loan program. The report suggests a buyer in Denver, Colorado with an income of $58,000 per year could buy the average home price of $315,000.
Yet a buyer with this income and 20% down could quite easily qualify for a $350,000 home provided minimal payments on other debts.
To qualify for the average home, a buyer in Denver could make as little as $50,000 per year or even less. The same idea applies to areas across the country. Buyers with great credit and low debt can afford more than studies estimate.
Lower Down Payments Could Be the Best Deal
It makes sense. The less a home buyer puts down, the higher the loan amount and monthly payment.
NAR estimates that a buyer in Washington, DC with 20% down needs to make $69,000 per year. The same borrower would need an income of $82,000 per year, or choose a more affordable home, if they put 5% down.
But is a lower payment worth the extra initial cash outlay?
Many would argue no. Financial and business experts often argue that “cash is king”. The cliché simply means that having extra cash on hand for emergencies is much better than a lower loan amount or monthly payment.
With housing, extra cushion in the bank is important.
A mortgage payment is due every month. But if homeowners who lose their source of income without cash reserves in the bank can lose their home. Even homeowners who have 20% down should think about hanging onto some of that cash.
But many buyers simply don’t have 20% down. Zero down home loans are incredibly popular because they require very little, if any money at all, out of pocket.
What’s more, the zero-down VA home loan and USDA home loan options come with even lower rates than are available for conventional loans. Many zero-down home buyers end up with lower payments than buyers who put 5% down.
Mortgage Rates Shift Affordability
The NAR report calculates income needed based on a 4% interest rate mortgage. Yet the average 30-year fixed rate has been below 4% thus far in 2015.
Small interest rate changes affect how much a buyer can afford. A buyer in Chicago, Illinois should make an annual income of $43,000 to afford the average home, based on NAR’s assumed 4% interest rate.
The home buyer could afford a home price 5% higher at a rate of 3.5%. In general, a 1% change in mortgage rate changes buying power buy about 11%. Fractions of this formula work out about the same, and in either direction, up or down.
This is why it is so important to buy at the right time. Mortgage rates are currently lower than they have been for most of the past two years. Home prices are still affordable compared to income. It is one of the best times in the last 40 years to break into the housing market.
Perfect Pre-approval Timing
Buyers across the country are realizing that they can afford a home, and are requesting pre-approvals before they shop for a home.
Most realtors will not show a home to a prospective buyer without seeing a pre-approval letter from a reputable lender.
Home buyers who don’t know how much they can afford should contact a lender and find out. After that first step, owning a home is not all that far away.