Affordability Peas in Your Pocket!

What is Affodability?

The question is triggered by two recent news releases from Scotia bank and the Royal Bank of Canada. Royal Bank qualifies their explanation of affordability with many rules, conditions and measures such as: size – the ’standard’ residence, types of taxes, and household income versus family income.

Explanations loaded with conditions, make understanding ‘affordability’ equivalent to finding the pea under the thimble almost impossible.

Can You Find the Pea in RBC?

RBC Economics says affordability measures show the proportion of median pre-tax household income required to service the cost of mortgage payments (principal and interest), property taxes and utilities on a detached bungalow, a standard two-storey home, a standard town house and a standard condo (excluding maintenance fees).

The qualifier ’standard’ is meant to distinguish between an average dwelling and an ‘executive’ or ‘luxury’ version. In terms of square footage, a standard condo has an inside floor area of 900 square feet, a town house 1,000 square feet, a bungalow 1,200 square feet and a standard two-storey 1,500 square feet. The measures are based on a 25% down payment and a 25-year mortgage loan at a five-year fixed rate and are estimated on a quarterly basis for each province and for Montreal, Toronto, Ottawa, Calgary and Vancouver metropolitan areas.

The measures use household income rather than family income to account for the growing number of unattached individuals in the housing market. The measure is based on quarterly estimates of this annual income,created by annualizing and weighting average weekly earnings by province and by urban area. (Median household income is used instead of the arithmetic mean to avoid distortions caused by extreme values at either end of the income distribution scale. The median represents the value below and above which lie an equal number of observations.

The housing affordability measure is based on gross household income estimates and, therefore, does not show the impact of various provincial property tax credits, which can alter relative levels of affordability. The higher the measure, the more difficult it is to afford a house. For example, an affordability measure of 50% means that home ownership costs, including mortgage payments, utilities and property taxes, take up 50% of a typical household’s pre-tax income.

Qualifying income is the minimum annual income used by lenders to measure the ability of a borrower to make mortgage payments. Typically, no more than 32% of a borrower’s gross annual income should go to “mortgage expenses” — principal, interest, property taxes and heating costs (plus maintenance fees for condos).

Scotiabank’s View

An affordability measure compares payments to income. It evaluates the carrying cost of home purchases using variables like interest rates at a particular point in time without strictly addressing the fair value of the asset itself. Affordability is often just an interest rate play.

Frick or Frack

According to the The McCaughey Centre from Australia -”There is no accepted definition of housing affordability.” Based on this, the discussion herein could stop. Assumed is that this is a down-under view?

In contrast, the US Government says that “the generally accepted definition of affordability is for a household to pay no more than 30 percent of its annual income on housing.” Americans always cut to the chase by taking a position! U.S. annual income remains unclear. Is that after Uncle Sam takes a few peas out of your pocket or before?

From the source of all knowledge, Wikipedia says that “housing costs…generally include taxes and insurance for owners, and usually include utility costs.

These definitions seem in one form or another directed at income – net or gross, taxes – provincial,state,national, municipal, or property with some mention of utilities. Few incorporate the ongoing costs that ownership entails.

What about everything else? What about maintenance, mowing the lawn, fixing the roof, the sidewalks, drainage and paint. These too are things that are part of the cost of affording a home. Simple things like buying a ladder so that you can wash the windows. If these simple things are not taken into account you could according to Scotiabank, be lessening the “fair market value” of your home by allowing the property or structures to deteriorate. Can you afford to not maintain the home and as such why shouldn’t this be factored into the affordability formula? It seems remiss to not have all the pieces to the home ownership puzzle.

Consider This BUT Not That!

When buying a Vancouver home it’s good to have a complete picture of costs. Seeing elements included or excluded in these bank definitions of affordability leaves ‘grey matter’ in discomfort. From this authors perspective these cost elements are all part of the home ownership package that must be reviewed and taken into account – none should be excluded.

By not taking these ‘other’ costs into the formula, the bank economist’s generate affordability numbers that leave many unprepared for the real picture. Their words-of-analysis as written, are to some extent, an imaginary dream. Buying a home in Vancouver? Check, make sure there will be enough peas in your pocket to pay for those things these formulas don’t mention. If your budget is limited, first talk to your homeowner friends and your REALTOR before proceeding – you don’t need surprise costs. They may render your home ownership dream a nightmare – one that finds you hiding under a thimble.

*Disclaimer: Reports Courtesy of RBC and Scotiabank