An affordability index is a measure of an average person’s ability to purchase a particular item, such as a house in a particular region. It can also measure their ability to afford the general cost of living in the region.
Key Takeaways
- Affordability indexes measure a person’s ability to afford an item compared to their income.
- These indexes can also measure according to the average income for their country or region.
- NAR's composite Housing Affordability Index is one particularly well-known affordability index.
- Varying levels of income for racial groups and other factors have been known to impact mortgage approvals.
What Is an Affordability Index?
An affordability index typically compares the price of a good or the general cost of living in a region to that of other regions or to some baseline measure of personal income. The resulting number may be presented as a raw ratio or normalized to a given index number. Affordability indexes can give an idea of the standard of living or attractiveness of a given region or area.
An affordability index is most often associated with housing costs. Housing affordability indexes compare the cost of purchasing a home in different locations. Housing is often one of the largest expenses a family faces so a housing affordability index is seen as an overall indication of the cost of living in that area.
However, there are more detailed indexes that can be used between areas that have nearly equivalent housing affordability index readings. A cost-of-living index goes far deeper than housing using the costs of a specified group of goods and services to allow for comparison on a city-by-city basis.
Housing affordability tends to fall during periods when real estate booms drive prices up faster than incomes do, which sometimes precipitates a market bust.
How an Affordability Index Is Used
There are several housing affordability indexes, but the composite Housing Affordability Index is one of the most watched in the United States. This index is published monthly by the National Association of Realtors (NAR). Itmeasures median household income relative to the income necessary to purchase a median-priced house.
This index uses the value of 100 to represent the position of someone earning a population’s median income. Values above 100 indicate that an item is more likely to be affordable and values below 100 indicate that an item is less affordable. Points below 100 indicate that a median family may struggle to qualify for a mortgage on a home in the area. A value of 100 indicates that the typical family has exactly enough income to qualify.
According to NAR's historical data, it's clear that housing in the United States has mostly been affordable as defined by a score of 100 or more and for a very long time. Major dips in the NAR index tend to coincide with periods of overheated housing markets when home prices on the market outpace incomes. This is often followed by severe financial crises.
This occurred during the late 1970s and into the early 1980s when the real estate boom that preceded the S&L crisis took off. A second dip toward 100 came from 2005 to 2007, preceding the housing market meltdown that triggered the Great Recession. Other than during those brief periods, however, the index has usually been well above 100.
The index sat at 169.9 in 2020, dropping to 108.8 in 2022 and then plunging to 93.7 by June of 2023.
The housing affordability index dropped below 100 for the first time in decades in June 2022 as housing prices, inflation, and interest rates rose.
Limitations of an Affordability Index
As a record of objective measures of incomes relative to mortgage approvals, NAR’s regularly published index doesn’t take race into account. However, NAR’s 2023 Snapshot of Race and Home Buying in America study provides an adjustment matrix for the index, showing that housing affordability does vary depending on whether the population is White, Black, Latinx, or Asian.
The homeownership rate for White Americans averaged 30% more than that for Black Americans from 2017 through 2021, according to the 2023 study.
Creditworthiness also varies due to differences in income and financing needs. In 2020, 7% of Black and Latinx homebuyers were denied mortgages compared to only 4% of White and 3% of Asian buyers. One explanation is that Black families tended to have a lower median income ($82,300) than White families ($101,900), as well as a lower average net worth: $188,200 for a typical White family versus $24,100 for a Black family.
These differences in affordability and its determinants unsurprisingly lead to differences in homeownership. The homeownership rate for White families was 72.1%, compared with 43.4% for Black families, 51.1 % for Latinx families, and 61.7% for Asian families.
States with few Black people tend to have few Black homebuyers:North Dakota (9%), South Dakota (13%), and Montana (16%) had the lowest homeownership rates among Black Americans.
Why Is Homeownership Important?
Aside from being a cornerstone of the American Dream, homeownership has been associated with better educational performance of children, higher participation in civic and volunteering activity, better health care outcomes, and lower crime rates in the communities.
What Does the NAR's Housing Affordability Index Measure?
The Housing Affordability Index measures whether a typical family earns enough income to qualify for a mortgage loan on a typical home at the national and regional levels based on the most recent price and income data. A typical home is defined as the national median-priced, existing single-family home as calculated by NAR and the typical family is defined as one earning the median family income as reported by the U.S. Bureau of the Census.
How Should You Interpret the Housing Affordability Index?
A value of 100 means that a family with a median income has exactly enough income to qualify for a mortgage on a median-priced home, assuming that they make a 20% down payment. An index above 100 signifies that such a family has more than enough income to qualify for a mortgage loan on a median-priced home. Levels below 100 indicate that they do not have enough income to qualify.
The Bottom Line
An affordability index measures how likely it is that an average individual can afford to purchase a particular item in an existing economy. That item might be something as significant as a home or just groceries. An index might also gauge their ability to afford the overall cost of living in an area.
The housing affordability index dropped significantly in June 2022 as housing prices, inflation, and interest rates rose. It might be something you want to keep an eye on if you're thinking of relocating to another region so you can factor long-term costs into your decision.
