- Qualifying for a loan to buy a $303,000 home – without violating 43 percent debt-to-income ratio rules – would require a minimum estimated annual income of $45,360. Almost 60 percent of U.S. households earn that much.
- Roughly 68.8 million households theoretically earn enough to purchase a $300,000 home. That number drops by just 3 percent assuming they’re looking to buy a $320,000 home.
Almost 60 percent of U.S. households earn enough money to theoretically buy a typical, newly constructed home priced at about $300,000 – and raising the price doesn’t thin the herd of potential buyers as much as may be expected, thanks in large part to very low mortgage interest rates.
Many buyers may be willing to stretch their budget a bit to buy their dream home, but the bank will only let them stretch so far – most lenders will not and cannot allow borrowers to take out a conventional loan that would cause their debt-to-income ratio to exceed 43 percent. In other words, if you have monthly income of $1,000, lenders will not allow you to take out a loan that would cause the portion of your expenses consumed by debt alone – car payment, credit cards, mortgage etc. – to exceed $430.
Zillow explored the impact of higher home prices on the number of Americans who could theoretically obtain a qualified mortgage, assuming the 43 percent debt-to-income ratio alone.
While many qualifications are weighed to identify qualified buyers, income data is readily available to understand the impact of price through the debt-to-income lens. To buy the median-valued U.S. home ($200,700 as of July 2017) with a 10 percent down payment and a 30-year, fixed-rate mortgage at a 4.5 percent interest rate, a buyer would need to earn a minimum of $32,400 a year to qualify. Roughly 83 million U.S. households, or 70.2 percent, make that kind of money.
But new construction homes tend to be more expensive. Builders generally build at the 70thpercentile of home value. Nationwide, that works out to a $303,000 home, and it requires a minimum estimated annual income of $45,360 to qualify. A majority (58.3 percent) of households earn that much.
But in terms of home prices, the jump from $200,000 to $300,000 is pretty drastic – a change of 50 percent. Looking at more modest changes in price, say increasing the home price by $20,000 from the 70th percentile (a price change of 6.6 percent) the number of potentially qualified buyers drops from 68.8 million to 66.8 million nationwide, a modest decline of only 3 percent.
Subsequent increases of $20,000 on top of that have progressively smaller impacts on the share of households who could potentially qualify to buy a home under the 43 percent rule, primarily because of the thinning out of the income distribution at ever-higher income levels.
The minimal impacts to the number of qualified buyers as prices modestly increase is partially because of prevailing low interest rates. If mortgage rates were closer to their historical levels, say 7 percent instead of 4.5 percent currently (or lower in many cases), only 48.6 percent of households nationwide could qualify for the 70th percentile home under the 43 percent debt-to-income rule. The same $20,000 hike in price would drop the number of qualified buyers by 5.9 percent. Currently low mortgage interest rates are also the main reason why the typical mortgage payment now takes up so much less household income than it did historically, despite national home values surpassing their pre-recession peaks and setting new highs.
When diving into individual metros, the impact on the number of qualified buyers when adding $20,000 to the home price has a lot to do with the general level of home prices in the area to begin with. For example, in San Francisco, a price hike of $20,000 on top of a 70thpercentile home – already valued at $1.16 million – doesn’t make much of a dent. While only 16.3 percent of San Francisco households could qualify for that mortgage by putting down 10 percent, adding $20,000 only drops the share to 15.9 percent.
In this analysis we sought to estimate the percent of the population with incomes high enough to qualify for a 30-year fixed rate mortgage, after putting 10 percent down and assuming various different home prices under the 43 percent debt-to-income rule for qualified mortgages.
Using individual household level income information from IPUMS-USA,[1] we estimated the monthly income distribution for the nation as well as individual metro areas. To estimate the income needed such that the mortgage payment plus non-housing debt payments take up no more than 43 percent of monthly income, we needed rough estimates of non-housing debt payments, namely average auto and credit card debt payments[2].
To create these estimates of average non-housing debt payments, we used 2017-Q2 debt per capita estimates from the Household Debt and Credit Report published by the New York Fed.[3] This data provides auto debt and credit card debt per capita for the population with a credit report, nationwide and for 11 states. For credit card debt payments, we simply assume the household is on the hook to pay 3 percent of debt outstanding, as a minimum. For auto debt, we use vehicle sales over the past five years[4] to estimate the average number of payments remaining for the average auto debt holder. Assuming a loan with a 4 percent[5]interest rate, we estimated the monthly auto debt payments by amortizing over the remaining number of payments estimated.
Assuming a 10 percent down payment, an interest rate of 4.5 percent, and a 30-year, fixed-rate mortgage, we estimated the income needed (and the share of the population earning that income) such that mortgage plus non-housing debt takes up no more than 43 percent of monthly household income.