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TeachMeFinance.com Affordability Index -- A measure of the pecuniary ability of consumers to purchase homes, as specified by the National Association of Realtors (NAR). An index below 100 means that a family with an income similar to the national median family income (as reported by the Census Bureau) is not entitled for mortgage on a characteristic median-priced home for one family. Likewise, an index or 100 or above means that a family qualifies or more than qualifies for mortgage (on the assumption of a 20% first payment). The effective rate on loans closed on current homes (as obtained from the Federal Housing Finance Board for the U.S. as a whole and from HSH Associates of Butler, NJ for different regions) determines the existing mortgage interest rate . Any mortgage is made up of an 80% loan (20% down payment) and a requirement, known as qualifying ratio, that 25% of the recipient's gross monthly income should match housing costs that include the cost of mortgage. The definition of gross income allows for anticipated principal and interest payments but excludes taxes and insurance.
The NAR works out three kinds of indices. The First Rate Index is derived by using the current effective interest rate on adjustable-rate mortgages. The Adjustable Rate Index is worked out upon the existing effective interest rate on adjustable-rate mortgages. The Composite Index is a weighted average of the interest rates on fixed and adjustable-rate mortgages, weights being given by the share of each type of mortgage on current homes.
For those buying homes for the very first time, the NAR estimates an Affordability Index that takes into account the unique traits of this section of consumers and the homes they are likely to buy. The class that has the greatest probability of purchasing a home for the first time is a young family that pays house rent, that has a person aged 25-44 as head of household, and that has income lower than the median. In calculating this index, the NAR assumes a down payment of 10% and increases the prevailing mortgage rate by one quarter of a percentage point. The price of a debut home is typically 85% of the median price for all homes currently purchased. A few economists are of the opinion that a unit increase in the mortgage rate leads to a fall of around 300,000 in home sales.
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