6 Affordability

Patterns of housing affordability are now examined. In Section 6.1 a model of housing affordability is developed. This model is then applied to non-homeowners and homeowners in Sections 6.2 and 6.3 respectively, allowing comparison of housing affordability across groups and over time. Regression analysis of housing affordability, similar to that of the previous section, is also undertaken for the sample of non-homeowners.

6.1  The model

There are many factors that will determine whether an individual or couple will find home ownership affordable. The model we use here incorporates information relating to four important influences of affordability: income; net wealth; house prices; and the structure of mortgage contracts (including the interest rate and mortgage term). This information is then used to ask whether or not a particular individual or couple could afford to service a mortgage on a lower quartile priced house in their region, with payments not exceeding a certain proportion of their income.

The first step is to determine the amount that an individual or couple needs to borrow (if anything) in order to purchase a home. This is calculated as the difference between the cost of a lower quartile priced house in the region which they live (obtained from QV) and any positive net wealth they have, which we assume is used as a deposit.

Required mortgage payments are then determined by the terms of the mortgage contract. We assume a standard table mortgage for a term of 30 years, and nominal interest rates equal to the average of 1-year fixed mortgage rates prevailing at the time (sourced from Reserve Bank of New Zealand series).

Of course nominal interest rates are comprised of real interest rates and inflation. It is well understood that inflation can have a substantial negative effect on the affordability of housing (see for example Modigliani and Lessard, 1975, Fischer and Modigliani, 1978 and Coleman 2008, 2010). Inflation results in 'front-loading' of mortgage repayments since it leads to larger real principal repayments during the early stages of homeownership (an issue known as mortgage-tilt). Further illustration and discussion of the effects of inflation on housing affordability are available in the appendix.

As real mortgage contracts are not available in New Zealand our focus here is on nominal housing affordability. This reflects 'actual’ affordability by highlighting the difficulties of meeting the terms and conditions of mortgage contracts currently available for those who need to borrow to purchase a house.[13]

Required mortgage payments are then offset against a proportion of the individual or couples income. Many variants are used in the literature, broadly falling into two categories (outgoings-to-income ratios and residual income measures), each with their own strengths and weaknesses (Robinson et al. 2006). In this case we adopt the so called '30 percent rule' where we say that an individual or couple would find it unaffordable to purchase a home if servicing the mortgage required more than 30% of their gross income.[14] In cases where an individual or couple have negative net wealth we use gross income after debt servicing costs have been deducted in our calculations of affordability.

This model is then applied to those aged 25 and older. Non-homeowners and homeowners are examined in turn. In the case of homeowners we relax the model to consider the affordability of the houses they currently own, as well as lower quartile priced houses in their respective regions.