Note to Editors: A chart accompanies the following real estate column by Dr. Leonard Zumpano, director of the Alabama Real Estate Research and Education Center, and Steven Stelk, research assistant.

By Leonard V. Zumpano, director, Alabama Real Estate Research and Education Center, and Steven Stelk, research assistant

TUSCALOOSA, Ala. – The Alabama Housing Affordability Index for the second quarter was 165.7, down 7.7 percentage points from the first quarter of the year when the HAI was 179.5. The sharp rise in home prices over the last few years coupled with a slight increase in interest rates during the second quarter is predictably having a depressing effect on housing affordability in the state. The statewide average selling price increased by a whopping 8.0 percent from the first quarter to $130,030. The average effective mortgage interest rate increased three basis points to 5.82 percent in the second quarter, according to the Federal Housing Finance Board.

Housing affordability is down nearly 35 percentage points from the high of 200 that was set during the first quarter of 2004. This very sizeable decrease in housing affordability reflects the fact that home prices have been increasing at a much faster pace than family income over the last few years. The rapid rate of home appreciation is making it increasingly difficult for low income households to realize the dream of homeownership.

The statewide housing affordability index is calculated as the ratio of the state’s actual median family income to the income needed to purchase and finance the state’s median priced home. An index number of 100 means that a family earning the state’s median income has just enough buying power to qualify for a loan on the state’s median priced, single-family home, assuming standard underwriting criteria. The construction of the index number assumes a 20 percent down payment; this assumption also allows us to compare housing affordability in Alabama to the U.S. The higher the index number, the more affordable is the housing.

An AHAI of 165.7 means that Alabama families who earn the statewide median income of $48,650 had almost 1.7 times the income needed to qualify for a loan to purchase the statewide median priced home, which was $130,030 in the second quarter.

Stated differently, a family earning the statewide median income of $48,650 could have qualified to purchase a home valued at $215,460. While this sounds good, it must be remembered that the median income numbers used in the computation of the HAI reflect mostly urban areas and, therefore, are well above income levels in more rural, less industrialized locations within the state.

Within Alabama, housing affordability fell in all areas tracked by AREREC with the exception of Auburn/Opelika and Monroe County. Auburn/Opelika saw a 1.5 percent increase in HAI due to a small decline in average selling price while Monroe County experienced a 20 percent increase in affordability due to a 17 percent drop in average selling price. Not surprisingly, home prices increased or remained relatively unchanged in all other areas tracked by AREREC.

While the rise in home prices has caused affordability to fall across the state, Baldwin County continues to be the only area with an apparent affordability problem in the second quarter with a HAI of 103.8, down from 107.6 in the first quarter of 2005. As was the case last quarter, this number has to be interpreted with care as it primarily reflects the very significant run up in prices for beachfront and vacation properties along the Gulf Coast. Many of these buyers live outside the county and though they tend to be more affluent than most county residents their incomes are not included in the county’s median income. Even so, service and agricultural workers living in the county are finding it increasingly difficult to find affordable housing.

At the national level, housing affordability fell 10.4 percent to 122.3 during the second quarter of 2005, as compared to an HAI of 136.5 in the first quarter. An 11.2 percent increase in home prices to $210,000 pushed affordability down at the national level. Housing affordability peaked at the national level, as was the case in Alabama, during the first quarter of 2004 at 144.8.

Affordability will continue to decline for the rest of the year if home prices continue to appreciate at current rates. In some markets across the country, consumers have purchased homes using variable rate, interest-only loans from sub-prime lenders as this has been the only way they could afford to get into the housing market. These markets will be particularly sensitive to any shock to the economy, and home prices could tumble.

This week the Federal Reserve raised the Federal Funds rate to 3.5 percent, triggering an increase in the prime rate to 6.5 percent. As interest rates on variable rate mortgages adjust upward, home financing costs will rise for many homeowners and speculators. Longer-term rates also appear to be increasing. Taken together with high home prices, housing demand in the second half of the year should begin to slow.

The Alabama Real Estate Research and Education Center is part of The University of Alabama’s Culverhouse College of Commerce and Business Administration. The UA business school, founded in 1919, has been recognized repeatedly for offering a high-quality, cost-effective education.