Housing affordability measures
The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median familial disposable incomes, expressed as a percentage or as years of income. It is sometimes compiled separately for first-time buyers and termed attainability.
This ratio, applied to individuals, is a basic component of mortgage lending decisions. According to a back-of-the-envelope calculation by Goldman Sachs, a comparison of median home prices to median household income suggests that U.S. housing in 2005 was overvalued by 10%. “However, this estimate is based on an average mortgage rate of about 6%, and we expect rates to rise”, the firm’s economics team wrote in a recent report. According to Goldman’s figures, a one-percentage-point rise in mortgage rates would reduce the fair value of home prices by 8%.
The deposit to income ratio is the minimum required downpayment for a typical mortgage, expressed in months or years of income. It is especially important for first-time buyers without existing home equity; if the down payment becomes too high then those buyers may find themselves “priced out” of the market. For example, as of 2004 this ratio was equal to one year of income in the UK.
Another variant is what the United States’s National Association of Realtors calls the “housing affordability index” in its publications. (The soundness of the NAR’s methodology was questioned by some analysts as it does not account for inflation. Other analysts,[who?] however, consider the measure appropriate, because both the income and housing cost data are expressed in terms that include inflation and, all things being equal, the index implicitly includes inflation
The affordability index measures the ratio of the actual monthly cost of the mortgage to take-home income. It is used more in the United Kingdom where nearly all mortgages are variable and pegged to bank lending rates. It offers a much more realistic measure of the ability of households to afford housing than the crude price to income ratio. However it is more difficult to calculate, and hence the price-to-income ratio is still more commonly used by pundits.[who?] In recent years,[when?] lending practices have relaxed, allowing greater multiples of income to be borrowed. Some[who?] speculate that this practice in the long term cannot be sustained and may ultimately lead to unaffordable mortgage payments, and repossession for many.
The Median Multiple measures the ratio of the median house price to the median annual household income. This measure has historically hovered around a value of 3.0 or less, but in recent years[when?] has risen dramatically, especially in markets with severe public policy constraints on land and development.
Inflation-adjusted home prices in Japan (1980–2005) compared to home price appreciation in the United States, Britain, and Australia (1995–2005)
Housing debt measures
The housing debt to income ratio or debt-service ratio is the ratio of mortgage payments to disposable income. When the ratio gets too high, households become increasingly dependent on rising property values to service their debt. A variant of this indicator measures total home ownership costs, including mortgage payments, utilities and property taxes, as a percentage of a typical household’s monthly pre-tax income; for example see RBC Economics’ reports for the Canadian markets.
The housing debt to equity ratio (not to be confused with the corporate debt to equity ratio), also called loan to value, is the ratio of the mortgage debt to the value of the underlying property; it measures financial leverage. This ratio increases when the homeowner takes a second mortgage or home equity loan using the accumulated equity as collateral. A ratio greater higher than 1 implies that owner’s equity is negative.