Written with the help of Maurice Finley; reposted with permission from Free and Clear.
In March, Free and Clear released our first analysis of how much home you could buy based on the median rent in the 20 most expensive U.S. cities.
The analysis sparked a lot of interest and touched upon important issues such as sky rocketing rents and housing affordability. Due to positive feedback and constructive input, we have updated the analysis to reflect current interest rates and rents and expanded the analysis from 20 cities to 40 to cover more of the country.
Our objective for the analysis is to promote borrower awareness and education while at the same time shining a spotlight on just how expensive it is to rent or buy a home in major cities across the country.
As a refresher, our analysis uses the median rent by city according to apartment listing website Zumper.com and determines the mortgage equivalent based on the median rent. In short, the mortgage equivalent is what size mortgage you could afford if your monthly mortgage payment was the same as your monthly rent payment.
For example, instead of paying $3,590 a month for rent in San Francisco (for a one bedroom apartment), what size mortgage could you afford based on a $3,590 mortgage payment? We use our Rent Payment Mortgage Affordability Calculator to determine the mortgage equivalent for all 40 cities based on current interest rates.
As we highlighted in our first analysis, it is important for borrowers to recognize that your mortgage payment is only one component of total monthly housing expense, which also includes property taxes, homeowners insurance and other applicable housing-related costs. The mortgage tax benefit, however, provides a financial cushion that can offset part or all of these costs.
The table below shows the mortgage equivalent for the cities based median rent, with San Francisco topping the chart at approximately $800,000 and El Paso coming in at number 40 with a mortgage equivalent of approximately $147,000 (based on $660 in rent).
The chart demonstrates the large mortgage amounts renters in many cities could afford and illustrates the wide gap between the most expensive and less expensive cities in stark fashion. (See the full list here.)
Just because you can afford a monthly mortgage payment does not mean you can qualify for a mortgage. Multiple factors including your credit score, financial profile, lender qualification requirements, down payment and other inputs determine your ability to qualify for a mortgage.
And most people who go from renting to having a mortgage can tell you it is usually significantly harder to qualify for a mortgage than a lease. Mortgage lenders also use debt-to-income ratios to determine what size mortgage borrowers can afford, which causes many prospective homebuyers to focus on how much money they need to make to qualify for a mortgage.
The table below shows the annual gross income required to qualify for the mortgage equivalent in each city.
For example, to qualify for an approximately $725,000 mortgage in New York requires approximately $130,000 in annual gross income, as compared to approximately $28,500 in gross income for an approximately $160,000 mortgage in Louisville.
Because lenders look at an applicant’s debt in addition to their income, we assumed a level of borrower debt as a percentage of income for the analysis.
The analysis shows that in 36 of the 40 cities — or 90 percent of cities — the median gross income is higher than the required income to qualify for a mortgage, which implies that more renters should consider buying homes. For the four cities where the median gross income is lower than the required income to qualify for a mortgage, the sizable gaps in New York ($48,000), San Francisco ($35,000), Miami ($16,000) and Los Angeles ($10,000) imply that the percentage of renters who actually make enough money to qualify for a mortgage to buy a home is much lower than in the other cities.
The chart below takes the analysis one step further and shows how the mortgage equivalent translates into home price for each city — basically what price home you can afford based on the median rent, assuming you make a 20 percent down payment.
For example, based on the median rent in Los Angeles, the mortgage equivalent is approximately $440,000. Assuming you make a 20 percent down payment, you could buy an approximately $550,000 home
It is important to highlight two points about the home price equivalent:
- First, it is certainly possible to buy a home with a down payment of less than 20 percent, and we are strong advocates of low or no down payment mortgage programs that make home ownership more attainable.
- Second, saving sufficient funds for a down payment ($200,000 in San Francisco) is one of the biggest obstacles to buying a home, so this is where the leap from renting to buying breaks down for many borrowers, especially in more expensive markets where higher rents make it harder to save for a down payment.
Despite the practical limitations for borrowers, the analysis reflects several interesting housing market trends. In 30 of the 40 cities, home price based on rent is higher than median home price, which suggests that more renters could afford to buy homes in those cities.
Cities with a home price based on rent lower than the median home price may have less affordable housing inventory for renters who want to buy. The analysis also shows the widening disparity in property values and affordability across different markets with the highest priced market, San Francisco, having a home price equivalent of $999,344. That is more than five times more expensive than the no. 40 market, El Paso, with a home price equivalent of $183,724.
The analysis up to this point has been based on the median rent for a one-bedroom apartment in each city, but how much mortgage and home could you afford based on the rent for a two-bedroom apartment?
The table below shows the mortgage equivalent, home price equivalent and the annual gross income required to qualify for a mortgage based the median rent for a two-bedroom apartment.
Once again, San Francisco tops the list with an eye-popping home price equivalent of $1.335 million (as compared to $1.275 million in March) based on $4,800 in monthly rent. The significant home price equivalents for many cities in the table below reinforces the one-bedroom rent analysis and underscores that more renters could consider buying homes.
Multiple personal and financial inputs go into the decision of whether to rent or buy a home, and we hope this analysis enables people to to better compare their options. With rising rents and multi-year low interest rates, prospective buyers may be more willing to take the home ownership leap, especially when they understand how much home they can buy with their rent.
Michael H. Jensen is the co-founder of FREEandCLEAR, where Maurice Finley is a marketing intern.