Affordability and the Funding Gap

I wrote this research paper with Mark Duda at the end of my job with NeighborWorks America.

Abstract below….

Affordability and the Funding Gap: Trends Among Low- and Moderate- Income Households, 1995–2005

By Mark Duda and Doug Foster — January 2007

Abstract

The period between 1995 and 2005 was a tumultuous one for low- and moderate-income (LMI) households seeking to purchase their first home. A booming housing market, stagnant incomes, and low interest rates taken together have presented both opportunities and challenges for these households. Meanwhile, regional disparities have increased markedly due to the different rates of price appreciation across housing markets. The upshot of these regional disparities is that LMI households can achieve homeownership without significant subsidies in some places, while in other places multiple layers of grants and concessionary financing, in combination with other policy tools, are the only hope for such families to ever achieve homeownership.

The severe erosion of housing affordability in many markets has undermined the ability of government and nonprofit organizations to promote homeownership attainment by blunting the effectiveness of their traditional policy approaches. The response to this situation is a two-stage process. First, the nature of affordability challenges must be understood at the market level, and metropolitan-level housing markets must be accurately classified based on the difficulty that low- and moderate-income households face in becoming homeowners in each place. Second, organizations operating in each market must have access to the right tools to help their clients become owners; the approach must be accurately matched to the affordability regime in the market(s) in which they operate.

This paper addresses the first issue. It develops a housing market typology based on affordability into which markets can be sorted, and to which homeownership policy approaches can be matched. The paper unfolds in several steps. It begins by deconstructing housing affordability into three elements — house prices, incomes and mortgage costs — and reviewing recent changes in each. It then looks at the performance of house price indexes over the past decade, explaining why they tend to show only small affordability declines despite substantial changes in house price. Following this, the paper examines affordability conditions for low- and moderate-income families in 127 housing markets using two measures: the change in affordability-index values and the gap between the maximum mortgage a household can afford and the amount required to purchase a modest home. Based on these results, we develop an affordability-based typology of market types that can be linked to policy interventions designed to promote homeownership attainment in each type of market.

Introduction

For those promoting homeownership among low- and moderate-income (LMI) households, the generally robust but geographically uneven performance of the housing market over the past decade has three key implications. First, the affordability of owner-occupied housing has declined substantially. Second, declining affordability has hit households at the lower end of the income distribution far more severely than those at the top. Third, the actual ability of LMI borrowers to become homeowners varies dramatically across housing markets. Taken together, these three factors present a different set of challenges for would-be owners and community-based organizations working on their behalf in the different types of markets.

This paper analyzes the deterioration and diversification of housing affordability in 127 housing markets. It begins with a background discussion of housing affordability, disaggregating it and discussing trends in each component over the 1995 to 2005 period. The paper then looks at the major affordability indexes, highlighting the key assumptions behind each, and explaining why affordability appears relatively stable for much of the study period, despite the major price run-up in much of the country. Next, the paper calculates affordability indexes and “funding gaps” for LMI households at the national and metropolitan area levels by varying some of the key assumptions behind the major indexes in ways that make the results more applicable to the situation actually faced by LMI households. Finally, the results of the analysis are used to develop an affordabilitybased typology of housing markets.

The fundamental conclusion of the paper is that the increased disparity in affordability conditions across markets requires that national initiatives take a segmented approach to homeownership promotion. That is, the approach that works in Toledo will not necessarily work in San Diego. Locating markets in this typology will help focus and improve ownership interventions in what has been an increasingly difficult market for most would-be LMI borrowers over the past decade.