How to calculate housing affordability

There is much coverage in the media of housing affordability, frequently expressed as the ratio of median house price to median income. This measure can be extremely misleading as it takes no account of the actual cost of servicing a mortgage, which is much more relevant to most buyers.

For example some of us can recall paying an interest rate of 20% on a mortgage of $100,000 in the mid 1980s, which would have the same repayment amount as a mortgage today of $500,000 at an interest rate of 4%. Of course earnings were lower in the mid 1980s, so the relative cost burden was actually higher.

The figure below compares an index of hourly earnings with an index of mortgage repayment costs based on median house prices. [1] On this measure of affordability the cost of servicing a mortgage relative to earnings in 2018 was very similar to what is was throughout the 1970s. However, there have been periods of much greater and much less affordability.

Graph 1

  • Between 1991 and 2005 mortgages were relatively more affordable than before 1991, largely because of falling interest rates.
  • However this situation reversed in the years leading up to the GFC, as house prices and mortgage interest rates rose rapidly.
  • Affordability improved markedly after the GFC as interest rates declined.
  • But since 2012 affordability has suffered as house prices have again risen strongly.

Even this measure of affordability, however, still omits some relevant factors. For example it does not allow for the effects of changes in minimum deposit regulations. Nor is hourly earnings necessarily representative of household income.  And of course there is no regional split.

Overall though it provides a much better measure of housing affordability than the rudimentary house price to income ratio.


[1] Strictly speaking the mortgage repayment cost index applies to interest-only mortgages or to the first few years of a regular table mortgage where the repayments are dominated by the interest component.

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