Schwab Guide to Economic Indicators: Housing Affordability Index

Charles Schwab & Co., Inc.

Call us at 866-232-9890

Send us an email

Printer-friendly
Type Size: A A A
Email to a friend

Schwab Guide to Economic Indicators: Housing Affordability Index
by the Schwab Center for Financial Research
November 30, 2007

What is it?
The housing affordability index (HAI) reflects consumers’ ability to purchase a home. It takes into account:

home prices (higher prices hurt affordability)
mortgage rates (higher mortgage rates hurt affordability)
family income (higher income helps affordability)

The index is produced by the National Association of Realtors® (NAR) monthly and quarterly. A similar, more-defined quarterly index covers first-time buyers.

What is its relative importance?
Medium. The index's importance increases when economic growth is thought to be near a turning point—up or down. The index is used in conjunction with other economic reports to gauge the direction and strength of the economy, and what the Federal Reserve might do next with short-term interest rates.

What impact does it have on the market?
In general, rising index readings can depict economic strength. Declining readings typically reflect economic weakness.

The following descriptions of economic and financial-market behavior are general in nature. See the "How is used?" section for more insight.

The overall economic backdrop and expectations of what is needed from monetary policy and where it's perceived to be headed play a major role with the direction of stock prices.

If the index is rising in a way that hints housing is overheating, bond prices could fall (yields rise) on the outlook for greater overall economic demand, potentially higher inflation and an increased chance that the Federal Reserve will hike interest rates. Stock prices may also fall.

Why?

A rise in bond yields can eventually make bonds more attractive once the fall in bond prices settles down. Compared to where the weights of stocks and bonds were in your portfolio, the typical thing to do in response to this change in valuation would be to sell a portion of your stock portfolio and put the proceeds into bonds. Even if corporate profit growth seems supported in this time of strong housing activity, the market will likely see it as being short lived given expectations for impending rate hikes and eventually slower economic growth.

There's a scenario where stocks prices could experience a temporary lift if the economic backdrop is subdued. Suppose the housing affordability index comes to life in a manner suggesting upcoming strength in the housing industry during an otherwise weak economic period. This can boost stock prices even with an expected rise in bond yields. That's because the market's expectation of potentially higher profit growth from greater economic demand can initially be the more influential factor in favor of higher stock prices. That is, for a period of time, it can be the more-dominant driver of stock prices, overshadowing the negative impact of rising bond yields (as discussed above).

While the renewed strength in housing might suggest an eventual need for Fed rate hikes, it probably wouldn't be deemed urgent because of an otherwise weak economic backdrop. It would likely take some time for other economic reports to strengthen to validate the existence of an economic recovery.

A weak index could lift bond prices (reduce yields) based on expectations of less inflation pressure. Suppose the economy is strong but monetary policy had recently become tight (restrictive). Stock prices could improve on hopes of a halt in the Fed's rate-hike campaign, along with the possibility of a future injection of economic stimulus if the next move by the Fed is a rate cut.

A weak index and a weak economy probably wouldn't help stock prices. That's because the chance of recession and reduced corporate profits would likely be the dominant fears.

How is it calculated?
The following describes the NAR's methodology:

The "affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home:

A typical home is defined as the national median-priced, existing single-family home as calculated by NAR.
The typical family is defined as one earning the median family income as reported by the U.S. Bureau of the Census.
The prevailing mortgage interest rate is the effective rate on loans closed on existing homes from the Federal Housing Finance Board and HSH Associates of Butler, N.J."

"These components are used to determine if the median income family can qualify for a mortgage on a typical home.

"To interpret the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20% down payment. For example, a composite HAI of 120.0 means a family earning the median family income has 120% of the income necessary to qualify for a conventional loan covering 80% of a median-priced existing single-family home. An increase in the HAI, then, shows that this family is more able to afford the median priced home.

"The calculation assumes a down payment of 20% of the home price and it assumes a qualifying ratio of 25%. That means the monthly principle and interest payment cannot exceed 25% of the median family monthly income," the NAR said.

In addition to providing a composite index, the monthly report breaks the index down by fixed-rate mortgages and adjustable-rate mortgages. It's also broken down by region:

Northeast
Midwest
South
West

How is it used?
The index helps analysts understand consumer's ability to purchase a home. The monthly index tends to receive the most attention because of its timeliness. It's also valued because it breaks the index down by mortgage type and geographical region.

The housing affordability index warrants special attention for several reasons.

First, falling mortgage rates can actually improve affordability when the overall economy is growing below its potential. Mortgage rates are closely tied to the yield of the 10-year Treasury note, which is tied to expectations of inflation and economic growth. If inflation or economic growth expectations or both are subdued, the yield of the 10-year Treasury note usually falls, thereby bringing mortgage rates down to more affordable levels. Yet, inflation typically has a greater affect on the movement of the yield of the 10-year Treasury note and mortgage rates.

For example, if the economy is expanding at a solid pace, supported by robust productivity growth, inflation would likely be contained. This could keep the yield of the 10-year Treasury note subdued and mortgage rates relatively affordable.

Home prices are also affected by the health of the economy. If the economy is strong, it likely means home prices are rising. But is this necessarily a bad situation? It probably isn't for consumers in general because family incomes could also be rising, thereby improving home affordability from that perspective. Furthermore, it clearly isn't a bad situation for established homeowners because they build greater equity and that provides a source for consumer spending.

However, rising home prices clearly hurt affordability for first-time buyers. Consequently, analysts use the affordability index for first-time buyers in conjunction with various other reports to gauge how the impact from rising home prices is affecting overall economy growth.

When is it released?
The monthly index is usually released near the 28th for the previous month. The quarterly indexes are released approximately 30-to-45 days after the close of the quarter. They can be found at the NAR's home page. From "Site by Topic," click on "Research" and then "Housing Statistics" to obtain the latest report.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

(2007-5771)

Return to Top