We begin the new decade with a strange real estate situation in Madison Park: the median price of houses for sale here is so far out of line with what the vast majority of home buyers could ever afford that it's just not possible for most home sellers to expect anything other than a long and frustrating sales process. As we noted in our real estate report last month, there are still "affordable" houses in Park, but they are few and far between. Only four houses are listed at under $1 million as 2010 begins.
To put the rarefied atmosphere of Madison Park real estate into perspective, I decided to ask a mortgage-financing expert to walk me through the loan underwriting process that a prospective buyer would face if purchasing a median-priced home here in the Park. (Again, the median price is that midway point where half the houses cost more and half cost less). Based on December’s listings, the median cost of a residence in this market is $1,995,000--the exact offering price, coincidentally, of the four-bedroom, 2,700 sq. ft. Washington Park home (located at 1009 37th Ave E.) pictured above.
What would it take to buy this house? In theory, of course, one could just plunk down the purchase price in cash. But as Priscilla Crutcher, vice president & manager of Golf Savings Bank’s Private Banking Group in Kirkland, notes, most home buyers are wary of liquidating investments in a down market in order to pay cash. If you need to finance, you’d probably require a jumbo mortgage—and the requirements to qualify for one are certainly much tougher today than they were at the height of the market.
Crutcher, who reports that she does a lot of financing of Madison Park homes, says that the starting point for underwriting a jumbo mortgage is to assess the applicant’s monthly income relative to his or her monthly debt payments. This is known as the “back ratio”: monthly installment and term debt payments divided by gross monthly income. In today’s environment, lenders may not finance someone whose back ratio is greater than 45%, Crutcher notes. In other words, all debt payments—mortgages, car loans, and credit cards included—cannot equal even half of an applicant’s income. There can be exceptions to this 45% “back ratio” guideline, Crutcher says, but this is the general rule.
Another way of evaluating an applicant’s ability to repay a mortgage is the “front ratio.” This measures the relationship between a borrower’s housing-related expenses (mortgage payments, taxes, and insurance) and his or her gross monthly income. In general, this ratio should be between 30-38%, according to Crutcher, but there are often other things a lender will take into consideration as well.
In our example of the $1,995,000 home, the maximum amount that probably could be borrowed in today’s market is 80% of the cost. For our example, however, we will assume a more likely 75% loan, which would result in a $1,496,250 mortgage. For this loan, a down payment of almost a half million dollars would be required, representing 25% of the home's cost.
Based on current interest rates of around 6.125% for this type of loan, the monthly mortgage payment (taxes and insurance included) would be about $11,000. If you assume that the applicant’s other required debt payments are no more than 22% of the mortgage payment, the applicant’s total monthly debt payments would then be about $13,500.
So what annual income would this applicant then need to qualify for a mortgage? The answer is $360,000 (monthly debt payments of $13,500 would require monthly income of $30,000 to meet the 45% maximum debt-to-income “back ratio” requirement). This is an income six times the estimated $60,000 median household income level for King County residents, as estimated by the U.S. Census for 2008.
Only 2.1% of U.S. households have annual income in excess of $250,000. So in cases where the buyer would need the maximum level of financing available, it’s a pretty small segment of the population that would qualify to purchase today’s median priced Madison Park house. Residences such as the Washington Park home pictured above, therefore, have what’s known as a “very limited audience.”
And that explains a lot about the state of our real estate market as we move into the New Year.