Rates slip, but are houses really affordable?
By Holden Lewis • Bankrate.com

The numbers tell you that this is a great time to buy a house because houses are so affordable. Do you believe the numbers?

According to the National Association of Realtors, houses are unusually affordable right now. The main reason is mortgage rates, which remain rock-bottom low.

The benchmark 30-year fixed-rate mortgage fell 3 basis points to match the modern-day low of 5.96 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.38 discount and origination points. One year ago, the mortgage index was 6.89 percent.

It's that falling mortgage rate that has helped make houses more affordable, according to the Realtors.

The Realtors' composite Housing Affordability Index stood at 140.7 in the last three months of 2002, meaning that the nation's typical household had 140.7 percent of the income needed to buy a home at the median existing-home price of $161,600.

The index measures the affordability of homes for families who make a 20 percent down payment. Raise your hand if you own your home and you made a 20 percent down payment. There is a good chance that your hand isn't in the air.

To make this perfectly clear, the Housing Affordability Index assumes that the "typical" household easily can afford a $161,600 house and has $32,320 in cash with which to make a down payment. The median family income in the fourth quarter of 2002 was $52,950, "which would qualify to buy a home costing $227,400," according to the Realtors. Presumably, that means that the family making $52,950 can afford a $45,840 down payment and a $181,560 home loan.

If that describes your family, the Housing Affordability Index is relevant to you.

"Essentially, the drop in mortgage interest rates, coupled with a modest rise in family income, more than offset an increase in home prices," says David Lereah, the Realtors' chief economist.

I work with someone who is looking for a house. He owns a townhouse, and now that he has a little boy, he and his wife want a single-family house on a lot that's big enough to have a yard for their son to play in. Houses don't look very affordable to them. They could get a small house with a tiny yard within bearable commuting distance, or get a spacious house with a big yard a long way from work. I think a lot of people share his dilemma, and they don't feel that houses are all that affordable.

Dean Baker, an economist and co-director of the Center for Economic Policy and Research, calls the Housing Affordability Index "economic malpractice" because "it fails to take account of how inflation (or lack of inflation) will affect the affordability of a mortgage payment through time."

During low-inflation eras such as this, workers' incomes rise slowly, Baker explains. Home buyers start out with a difficult-to-afford mortgage and the payments remain hard to pay. In times of high inflation, incomes rise faster and it becomes easier to make the house payments over time, Baker says.

After failing to control inflation during the 1970s and 1980s, the Federal Reserve finally has convinced investors that we're in a long-lasting era of low inflation.

Even as they trumpet the rising affordability index, the Realtors are joining with eight other groups to announce proposals "for easing the severe nationwide affordable housing crunch." The coalition, organized by the National Housing Conference, will make its proposals Feb. 10.

It sounds like the Realtors really do understand that high home prices pose a problem, notwithstanding the rosy news from the Housing Affordability Index. The Realtors do have a First-Time Homebuyer Affordability Index, which shows that a typical first-time-buyer household has 81.3 percent of the income needed to buy a starter home with a 10 percent down payment. The index assumes that a typical first-time buyer is 25 to 44 years old, has a household income of $36,960 and is buying a house for $137,400.

"The typical first-time buyer could afford a home costing $111,700 in the fourth quarter, which will buy a small, single-family home in much of the Midwest and South," says Realtors President Cathy Whatley.

That sort of puts you behind the eight ball if you live in California or the Northeast.