You are looking to buy a new home. You set up a meeting with a real estate broker to get the ball rolling. One of the questions you are likely to be asked is how much you can afford to spend. For some people, that question immediately leads to thoughts of monthly mortgage payments and taxes. Others think along the lines of sale price.
Monthly mortgage payments are often used as a measure of affordability because they are fairly easy to calculate. A real estate agent only needs to estimate the sale price, factor for the client’s down payment, and then calculate a 30-year mortgage based on prevailing interest rates. In under a minute he or she can know what his/her client will likely pay per month.
Measuring affordability by looking at monthly mortgage payments is certainly valid. But mortgage payments do not tell the whole story. They only give buyers a snapshot of one aspect of purchasing a new home. There are plenty of other things to look at – both financial and non-financial.
Affordability and Home Prices
Affordability as defined by monthly mortgage payments accounts for three primary factors: purchase price, down payment, and interest rates. Of the three, the purchase price is the greatest influence. It goes without saying that your monthly mortgage payment will be higher the more you spend.
It is interesting to note that average mortgage payments have fallen considerably in some parts of the country. For example, recently released research shows that Los Angeles residents are paying an average of $171 less in mortgage payments today as compared to what they were paying in 2016. Other cities boasting lower mortgage payments include Denver, Dallas, Charlotte, and Houston.
Average mortgage payments have gone up in other cities. Among the highest is Salt Lake City, Utah, where homeowners are paying $418 more today than they were in 2016. Other expensive cities include Washington DC, Seattle, Phoenix, and Orlando.
Interest rates are at historically low levels around the country and are expected to remain there for some time. So why the disparity? It boils down to sale price. Salt Lake City has higher monthly mortgage payments because homes cost more. And according to CityHome Collective, homes cost more because the area’s economy is strong. There are jobs to be had as companies move into the area.
On the other hand, Southern California is losing residents. Local economics are not as strong thanks to the rise of remote work and tech jobs leaving the area. LA’s weaker economy is pushing home prices down.
Overpaying for a House
The disparity in home prices raises an alarming question: are some buyers overpaying for new homes? The same research that showed some markets having higher monthly mortgage payments than others also warns that a 10% increase in sale prices could easily price out the average buyer.
It seems as though housing prices have risen abnormally fast in the last few years. Given that housing is a supply and demand business, it is reasonable to assume the robust economy of the last four years is a big reason for rising prices. But could we be headed for another bubble and crash?
Any such potential dictates that buyers and real estate brokers exercise caution. Just because monthly mortgage payments may be falling in some areas, buyers should not necessarily be overpaying for homes. Doing so puts them at risk of being underwater in the event of a major downturn.
Monthly mortgage payments do not tell the whole story. They should not be the primary gauge of whether or not buyers should purchase a particular home.