Over the past two posts, we’ve argued that the most common measure of housing affordability – whether someone is paying more than 30% of their income – has a lot of serious problems. For one, housing costs are only one facet of overall location costs: if you move from the city to the suburbs for cheaper housing but end up having to buy a car, you might not be saving any money at all. On top of that, the 30% metric ends up telling us that lots of wealthy people who choose to spend lots of money on luxury housing are “burdened,” while a lower-income person who spends less than 30% of their money on housing but still doesn’t have enough left over for other necessities is not.
We also suggested that a “capabilities-based” approach to housing affordability – one that’s focused on whether the price of a given location allows people to have access to the basic building blocks of modern American life – might end up with something very much like the “residual income” approach advocated by Michael Stone of Boston University. With that measure, you subtract the location-based costs a household pays from their total income, and compare what’s left over – the “residual” – to what they need to spend on other necessities like food, clothes, and telecommunications.
Both of those posts focused mainly on renters. In this post, we’ll look at owner-occupied homes – where the situation is even more complicated.
Why is trying to grasp what “affordability” means to someone who owns their own home complicated? Probably the biggest issue is that unlike rent, your mortgage payments are really buying two products: a place to live, and an investment vehicle. For the vast majority of homeowners, a home is a wealth-building engine that they hope will appreciate in value, so that one day it can be sold at a profit, either for themselves or their children. In principle, the idea isn’t terribly different from buying a stock portfolio.
Housing wealth makes up close to half of total American household wealth, and can help pay for college tuition, retirement, and other important life events. In other words, it’s very important – but it’s not exactly as necessary as having a roof over your head. As a result, it doesn’t really make sense to include home-as-investment-vehicle in basic measures of affordability. At the very least, it may make sense to discount the potential profit a homeowner can expect to earn from their investment against their mortgage payments.
But there are several complications to doing that. For one, we can’t necessarily know how much a home is going to appreciate in value, or whether it will appreciate at all. On top of that, the profit that a homeowner enjoys comes at a different time than their house payments – in other words, they have a cash flow problem. Imagine a retiree on a fixed income whose home value increases dramatically: she is now much wealthier on paper, but may not be able to actually make her property tax payments because she can only access that wealth by selling her home.
On the other hand, because homeowners expect this payoff – and because many homeowners expect to live in their homes for many years – a buyer may decide to spend more money on their home than they would otherwise be willing to spend. Buyers may also take into account that their incomes are likely to rise over the time they are living in their home. Imagine a 30-year-old buying his first home, and planning on living there for up to ten years. By the time he’s 40, his income will probably be higher – and knowing that, he may be willing to pay more for a home than he would be willing to spend on rent.
In practice, it still makes sense to use the same residual income method to measure owner-occupied housing affordability. But when it comes to looking at particular policies, taking into account the dual shelter/investment nature of homeownership is important. For example, homeowners in neighborhoods where housing values are rapidly appreciating may find that their property tax bills are higher than they anticipated when they bought – and higher than their income allows them to pay without making unreasonable sacrifices. While some advocates have suggested property tax forgiveness in these cases, property tax delay may actually make more sense. After all, a homeowner’s rising tax bill is a sign that they are becoming wealthier – just in a way that doesn’t change their immediate cash flow. Rather than giving a tax break to someone experiencing a windfall, and denying local governments revenue for essential services, it may be better to simply collect them if and when the homeowner actually sells their home and experiences the gains from their investment.
But either way, using a 30% ratio of housing costs to income isn’t going to give us a good idea of who is really burdened by unaffordable housing and who isn’t. For both renters and homeowners, we need something new. The residual income approach does a much better job of indicating when a given household is capable of paying both for housing and the other necessities of a modern American life. It deserves a more prominent role in our ongoing affordability debates.