- In the third quarter, home buyers could expect to spend 15 percent of their monthly income on a mortgage payment for a typical home, while renters could expect to spend 30 percent of their income renting a median-valued home.
- Rental affordability is worse currently compared to historic norms in all but one of the 35 largest metros, making it difficult for renters to save money for a down payment.
Comparatively low monthly mortgage payments, coupled with increasingly expensive rents, continue to make homeownership a relative bargain to millennials and other potential home buyers. But there’s a catch.
Getting the best interest rate on a mortgage, and the low monthly payments that come with it, typically requires a down payment of tens of thousands of dollars in most areas, and hundreds of thousands of dollars in some. And coming up with that kind of cash is increasingly difficult as rents and home values alike continue to rise.
Nationwide, a home buyer making the national median income ($54,990) and purchasing the median-valued U.S. home ($182,500) during the third quarter could expect to pay around 15 percent of their income towards payments. On the flip side, if the same household chose to rent a typical home, they could expect to pay slightly more than 30 percent of its income towards median rent.
Of course, the 15 percent calculation assumes the buyer had the $36,500 on hand necessary to pay for a 20 percent down payment on the median U.S. home – a figure that varies dramatically from market-to-market depending on local home values. In many areas, a 20 percent down payment is a significant chunk of cash (figure 1).
In San Francisco and San Jose, among the priciest markets in the country, a 20 percent down payment on the median-valued local home represents more than $150,000, almost three times more than the typical U.S. household earns in a year and only about $30,000 less than the median U.S. home value. According to the New York Times, an annual income equal to the median 20 percent down payment required in the Bay Area would put a household into the top 8 percent of all household incomes nationwide.
Of course, smaller down payments are an option for many, but also often come with higher interest rates and private mortgage insurance (for down payments less than 15 percent), which both conspire to raise monthly payments and consume a larger share of monthly income.
What’s more, rising rents and fairly flat income growth are making it hard to save for a down payment in the first place. The share of income needed to afford median rents rose in 28 of the 35 largest U.S. metros over the past year. In other words, renters’ money that could be going into the piggy bank for a future down payment is instead going into landlords’ pockets.
As a result, first-time homebuyers and millennials, in particular, are left trying to find other ways to come up with a down payment in order to break into the housing market, often turning to friends and family for financial help. In 2014, 13 percent of home purchases were bought with help from a loan or gift from friends or family as part of the down payment.
A Moving Target
And on top of it all, down payment amounts themselves are a rapidly moving target – the amount needed for a healthy down payment keeps rising.
As recently as 2012, just after the national housing market bottomed out after the recession, a 20 percent down payment represented a lot less cash. For example, a 20 percent down payment for a median Bay Area home currently costs roughly $50,000 more than it did in Q3 2012 ($153,600 for a median home valued at $768,000 currently, vs $103,360 for a median home valued at $515,100 in 2012). Homeowners in San Diego and Los Angeles would need more than $20,000 in additional upfront cash in 2015 than they would have in 2012 to purchase the median-valued home in their area.
In Denver, one of the hottest markets in the country, buyers in 2015 needed an additional $18,620 compared to Q3 2012 in order to put 20 percent down on a median-valued Denver-area home. Put another way, that’s a more than 40 percent increase in the funds necessary to afford a 20 percent down payment in and around Denver. But over the same time period, Denver-area incomes grew just 13 percent.
A Wrench in the Works?
All in all, rising rents are making it harder for hopeful buyers to save for a new home, and as home values themselves rise, the amount of cash in the bank needed to buy a home is rising too. And a possible third wrench in the works is the potential for rising mortgage interest rates.
The Federal Reserve has been hinting at raising key interest rates for months, though luckily for buyers, rates have remained at historically low levels for most of the year. How much longer rates will stay low, however, remains to be seen. And when they rise, mortgage affordability will suffer – regardless of down payment (figure 2).
To calculate mortgage affordability, we first calculate the mortgage payment for the median-valued home in a metropolitan area by using the metro-level Zillow Home Value Index for a given quarter and the 30-year fixed mortgage interest rate during that time period, provided by the Freddie Mac Primary Mortgage Market Survey (based on a 20 percent down payment). Then, we consider what portion of the monthly median household income (U.S. Census) goes toward this monthly mortgage payment. Median household income is available with a lag. For quarters where median income is not available from the U.S. Census Bureau, we calculate future quarters of median household income by estimating it using the Bureau of Labor Statistics’ Employment Cost Index.
The affordability forecast is calculated similarly to the current affordability index but uses the one year Zillow Home Value Forecast instead of the current Zillow Home Value Index and a specified interest rate in lieu of PMMS. It also assumes a 20 percent down payment.
We calculate rent affordability similarly to mortgage affordability; however we use the Zillow Rent Index, which tracks the monthly median rent in particular geographical regions, to capture rental prices.
Assuming a 20 percent down payment on a 30-year, fixed-rate loan at prevailing rates, and only accounting for principal and interest payments.