The variables that drive residential real estate prices can be grouped into macro forces and micro forces. Macro forces include mortgage interest rates, economic strength (the business cycle), demographics, and federal taxes. Micro forces include local economic strength, state and municipal zoning, neighborhood features (such as quality of schools), and the condition of the property itself.
The biggest factor influencing home prices are income levels. Home prices are limited in how far they can rise by the incomes of potential buyers. Since eighty percent of all homes purchased are purchased with a mortgage, the ability to make payments, borrow money, and the cost of borrowing money are major influences limiting how far prices can rise before hitting resistance due to prices hitting levels where potential are unable to qualify. In general the ratio in the US are home values at 2-4 times income levels.
Responsible lenders use what they refer to as “front-end” ratio which consists of income/mortgage payments to determine how much of a mortgage a person or family can qualify for and safely handle. This front-end ratio is generally a maximum of 28% of a borrower’s monthly gross income that can be allocated toward housing expenses including the mortgage payment, insurance and property taxes. For example, a lender would allow a person with a $5000 monthly gross income to allocate $1400 per month for mortgage payments, fire insurance and property taxes. ($5000 x 28% = $1400) So with $1200 available for monthly mortgage payments, after subtracting $200 for insurance and taxes, $1200 would support a $200,000 mortgage.
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