What Affects Affordability Assessment

Interest rates are the single biggest factor affecting affordability assessment, as they directly influence the cost of borrowing and can increase or decrease affordability by up to 20% depending on the rate and loan amount, such as when a 1% decrease in interest rates can save a borrower $140 per month on a $200,000 mortgage.

Main Factors

• Income level — the higher the income, the higher the affordability, as it increases the amount that can be spent on housing or other expenses, with a 10% increase in income corresponding to a 5% increase in affordability, as seen in the case of a $50,000 increase in annual income for a household earning $500,000, which can afford a $1.1 million home, up from $1 million.
• Debt-to-income ratio — a lower debt-to-income ratio increases affordability, as it indicates a lower proportion of income spent on debt repayment, with a 5% decrease in debt-to-income ratio corresponding to a 3% increase in affordability, such as when an individual reduces their debt payments from 30% to 25% of their income, freeing up $300 per month for other expenses.
• Credit score — a higher credit score increases affordability, as it leads to lower interest rates and better loan terms, with a 100-point increase in credit score corresponding to a 1% decrease in interest rates, such as when an individual with a credit score of 750 qualifies for a 4% interest rate, while an individual with a credit score of 650 qualifies for a 5% interest rate, resulting in a $60 per month difference in mortgage payments on a $200,000 loan.
• Inflation rate — a high inflation rate decreases affordability, as it erodes the purchasing power of income and increases the cost of living, with a 2% increase in inflation rate corresponding to a 1% decrease in affordability, such as when a 2% increase in inflation reduces the purchasing power of a $50,000 income by $1,000.
• Housing prices — higher housing prices decrease affordability, as they increase the cost of housing and reduce the amount that can be spent on other expenses, with a 10% increase in housing prices corresponding to a 5% decrease in affordability, such as when a $200,000 home increases in price to $220,000, requiring an additional $20,000 in savings or income.
• Taxes and fees — higher taxes and fees decrease affordability, as they increase the cost of housing and reduce the amount that can be spent on other expenses, with a 1% increase in property taxes corresponding to a 0.5% decrease in affordability, such as when a 1% increase in property taxes on a $200,000 home increases the annual tax bill by $2,000.

How They Interact

The interaction between interest rates and income level can amplify or cancel each other, as a decrease in interest rates can increase affordability, but a decrease in income level can offset this effect, such as when a 1% decrease in interest rates increases affordability by 5%, but a 5% decrease in income level reduces affordability by 3%, resulting in a net increase in affordability of 2%. The interaction between debt-to-income ratio and credit score can also amplify or cancel each other, as a lower debt-to-income ratio can increase affordability, but a lower credit score can offset this effect by leading to higher interest rates, such as when an individual with a debt-to-income ratio of 25% and a credit score of 650 qualifies for a 5% interest rate, while an individual with a debt-to-income ratio of 30% and a credit score of 750 qualifies for a 4% interest rate. The interaction between inflation rate and housing prices can also amplify or cancel each other, as a high inflation rate can decrease affordability, but an increase in housing prices can offset this effect by increasing the value of the home, such as when a 2% increase in inflation reduces the purchasing power of income by $1,000, but a 10% increase in housing prices increases the value of the home by $20,000.

Controllable vs Uncontrollable

The controllable factors are income level, debt-to-income ratio, and credit score, which are controlled by the individual, as they can increase their income, reduce their debt, and improve their credit score through financial planning and discipline. The uncontrollable factors are interest rates, inflation rate, housing prices, and taxes and fees, which are controlled by external factors such as the economy, government policies, and market conditions, and can only be mitigated by the individual through strategies such as hedging against inflation or taking advantage of low interest rates.