Academic journal article Economic Review - Federal Reserve Bank of Kansas City

The Affordability of Homeownership to Middle-Income Americans

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

The Affordability of Homeownership to Middle-Income Americans

Article excerpt

(ProQuest: ... denotes formulae omitted.)

From 1971 through mtd-2007, the nominal national sales price of housing grew almost eightfold. Controlling for inflation, this represented a near doubling in the relative price of housing. The retrenchment in prices that began in 2007 has so far remained small compared to the earlier increase.

As house prices climbed, many people complained that housing had become unaffordable to middle-income Americans. As early as 1 998, newspapers warned that homeownership was becoming a heavy financial burden. As sales price rises accelerated in 2003 and crested in 2006, homeownership was increasingly portrayed as the "unattainable" American dream (Strickand; Fogarty; Simon; Fessenden; Scott and Archibold).

Notwithstanding such concerns, homeownership actually rose strongly beginning in the mid-1990s and in 2004 attained its highest level ever. The more recent surge in foreclosures suggests many households indeed purchased homes they could not afford. Still, this does not necessarily imply that housing in general has become unaffordable to middle-income households. Instead, it may be that many defaults resulted from specific households purchasing specific houses whose location, size, and other attributes made their sales price too high relative to the purchasers' financial resources.

This article seeks to answer the question of whether homeownership has indeed become less affordable to middle-income Americans. Assessing afTordability is difficult because the "affordability" of housing is a vague concept, both from theoretical and measurement points of view. Theoretically, it is not clear how to compare the financial obligations of ownership with household financial resources. More practically, it is unclear how to measure "middle income" resources and the financial obligations associated with owning a representative house.

In terms of theory, a common affordability comparison of obligations and income is to divide the former by the latter. The resulting ratio gives the housing expenditure share of income. Intuitively, ratio affordability captures what share of the "pie" housing obligations constitute. A problem with the expenditure share concept of afTordability is that it cannot determine whether changes in income and homeownership obligations make people better or worse off.

An alternative afTordability comparison subtracts obligations from income. The resulting residual income concept of homeownership affordability is preferable because ir correctly reflects changes in household welfare as income and homeownership obligations change. Intuitively, residual income afTordability captures how much of a "pie" that changes size is left over after meeting the financial obligations of homeownership.

In terms of results, the estimated housing share of expenditures increased significantly between 1971 and 2007, implying a decrease in afTordability by the ratio concept. However, the absolute dollar increase in representative homeownership obligations was smaller than the absolute dollar increase in representative household income. Hence the residual income concept of afTordability improved. Why, then, have there been so many concerns on the afTordability of homeownership? One possible explanation is that the growth of residual income from 1971 to 2007 was considerably slower than residual income growth during the 1950s and 1960s. Another possible explanation is that the increase in residual income from 1971 to 2007 depended in part on a sharp increase in women's labor force participation. Had women continued to participate at their 1971 rate, residual income would likely have decreased.

The first section of this article describes some important considerations in measuring affordability, such as what it means to be "middle income" and what constitutes a "representative house." The second section examines the historical behavior of the two main components of affordability: household income and the required payments associated with homeownetship. …

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