Conflicting conclusions on housing affordability

David MoonBlog

According to the Federal Reserve, Americans only spend 4% of their disposable income on mortgage debt service. However, real estate brokerage Redfin has determined that the typical American household would require 35% more income to afford the median-priced U.S. home.

A third source, the National Association of Realtors (NAR), produces a Housing Affordability Index, which measures “the degree to which a typical family can afford mortgage payments on a typical home.” Based on the current index level of 101.1, the NAR data signifies that the typical American family has slightly more than enough income to qualify for a mortgage on a median-priced house.

All three sources are correct, yet they present conflicting conclusions.

Which is why it is completely acceptable – no, advisable – to question supposed authority figures, especially when something fails the smell test. Taken in total, these three data series do not pass the smell test.

The Federal Reserve’s calculation that mortgage service payments equal only 4% of American’s disposable income is an aggregate calculation. This includes the disposable income for all Americans in the denominator but ignores the 35% of people who rent and the 40% of homeowners with no mortgage. The Fed’s calculation also only includes the interest component of monthly mortgage payments, not principal reductions or taxes. And importantly, the Fed’s calculation focuses solely on existing homeowners, effectively ignoring the current state of housing prices.

By contrast, Redfin’s calculations are based on median U.S. family income (currently $84,000) and the median house sales price in the most recent available month ($413,000). Redin assumes that “affordable” means spending 30% of income on housing. A significant (and flawed) Redfin assumption is that buyers make no down payment. I haven’t bought a house in more than 25 years, but it’s hard for me to imagine banks making 100% loans on $400,000 houses. If they are, expect another mortgage crisis.

The National Association of Realtors Housing Affordability Index is calculated similarly to the Redfin method, except it assumes that median income families make a 20% down payment to buy the median-priced home, thus reducing the assumed monthly mortgage payment (including both principal and interest) by 20%. Voilà! Affordable housing!

There are very few true contradictions in life, and if you think you are faced with one, it’s probably the result of conflicting assumptions. You can decide for yourself if the Federal Reserve, Redfin or National Association of Realtors is “wrong” in their assumptions, but they certainly have different approaches. At the individual level, housing affordability is a simple issue; you can afford a house, or you can’t. But at a macroeconomic level, it is more complex than can be captured in a single figure.

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.