If mortgage rates return to their historic norm of 7 percent, only one-third of U.S. homes will remain affordable, according to a new report.
Following the Federal Reserve's announcement that it will trim its bond buying program -- which will certainly send mortgage rates upward over time -- Freddie Mac did some math to find out exactly how rising interest rates will affect affordability.
At a 4.4 percent interest rate, the average for a 30-year fixed rate mortgage over the third quarter of the year, more than 70 percent of the country's homes remained affordable for a middle class family. Freddie Mac considers a mortgage affordable when it costs a homeowner 28 percent or less of their monthly gross income, a standard rule of thumb for housing affordability.
"While most housing markets still remain affordable, rising mortgage rates and rising house prices over the past six months are making it more challenging for the typical family to purchase a home without stretching beyond their means, especially in the Northeast and along the Pacific Coast," said Frank Nothaft, Freddie Mac vice president and chief economist, in a release.
Even with today's interest rates, only 36 percent of the West Coast is currently affordable. To afford a home in San Jose, where the median price topples $800,000, a homeowner needs to make at least $100,000 a year to comfortably afford a mortgage. Meanwhile, in Indianapolis, where the median price is only $144,000, a homeowner must make only $56,000 a year to comfortably pay for a mortgage.
Over time, even affordable areas will get crunched when interest rates rise.
At a 5 percent interest rate, with no changes in income or home prices, that number drops to 63 percent. At 6 percent interest, only 55 percent of homes would be affordable and at the historic norm of 7 percent -- only 35 percent are affordable.
Mortgage rates have already crept up to 4.47 percent from 4.42 percent this week in the lead-up to the Fed's taper announcement Wednesday. At the start of the year, interest rates for a 30-year fixed mortgage were only 3.34 percent.
As the Fed tapers its stimulus program next year, and the economy improves, it's likely that interest rates will increase at least as much as they did this year, if not more.
It's critical then that we start to see significant job gains and income growth next year, Nothaft said.
Freddie Mac has an interactive map on its website, which includes a calculator where homebuyers can check to see how affordability will change in their area as interest rates rise.