Housing Affordability Indexes for the Boston region

Goals

To recommend a Housing Affordability Index for the Boston region
  • Deconstruct the methodology (definitions and models) supporting the following "housing affordability" Indexes for Boston: The National Association of Realtors® affordability index; National Association of Home Builders/Wells Fargo Housing Opportunity Index; Federal Reserve Bank of Boston`s Housing Affordability Measure.
  • Understand the inputs/factors driving the result behind each measure, and identify the common drivers and differences among them
  • Recommend a housing affordability index for Boston, explaining reasons for the recommendation and considering one of the following approaches: choose one of the above mentioned indexes; propose a blend of multiple indexes into a single meta-model; propose an alternative way of indexing “housing affordability” for Boston.

Early Findings

Data Availability

The initial round of research indicates that there is information available on the public domain on the three indexes. Explanations about the methodology related to the National Association of Realtors® Affordability Index and the National Association of Home Builders/Wells Fargo Housing Opportunity Index are available on their websites. Regarding the Federal Reserve Bank of Boston`s Housing Affordability Measure only researches and data associated to the measure were found in this initial hour of research. Further work is needed to have complete information about the methodology behind it.

National Association of Realtors® affordability index

Definition:

This index measures “the degree to which a typical family can afford the monthly mortgage payments on a typical home”. For this definition, the following clarifications are needed: A typical home is the national median-priced, existing single-family home" (comes from the existing home sales monthly survey conducted by the National Association of Realtors®); a typical family is “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” The effective mortgage rates is reported by the Federal Housing Finance Board monthly. The effective rate reflects the amortization of initial charges.

Interpretation of scores:

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 “a family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home”.

For the calculation, it is assumed a down payment of 20% of the home price. It is also assumed 25% as a qualifying ratio. In this regard, principal and interest payment cannot exceed 25% of the median family monthly income.

Formula:

Index: (MEDINC/QINC)*100

Its components are the following,

QINC: PMT * 4 * 12
MINC: ((PMT*12)/MEDINC)*100
PMT: MEDPRICE*.8 * (IR/12)/(1-(1/(1+IR/12)^360))
R = Interest Rate
MEDPRICE = Median price of existing single-family home sale
PMT= Monthly payment (principal & interest payment)
MEDINC = Median Family Income
MINC = Necessary Monthly Income
QINC = Qualifying Income, necessary to qualify for a loan for the median-priced home

For the MEDINC, data comes from the Income data from the Census Bureau American Community Survey. Census income data is not available for later than 2017, so data for later than 2017 is based on the average of wage growth and last year’s actual income growth.
For the MEDPRICE, data comes from the existing home sales monthly survey conducted by the NAR.
The effective mortgage rate is reported by the Federal Housing Finance Board monthly. It reflects the amortization of initial charges.

National Association of Home Builders/Wells Fargo Housing Opportunity Index (HOI)


Definition:

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is “the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria”.

Interpretation of scores:

A score equal to 80 means that 80% of homes in that area have been affordable to a median income family. A score equal to 50 means that 50% of homes in that area have been affordable to a median income family.

Components:

There are two major components, income and housing cost.

For income, the index uses the annual median family income estimates for metropolitan areas published by the Department of Housing and Urban Development. It assumes that a family can afford to spend 28% of its gross income on housing; this is a conventional assumption in the lending industry. That share of median income is then divided by 12 to arrive at a monthly figure.

For housing cost, it is considered principal, interest, estimated property taxes, and property insurance. The monthly principal and interest that an owner would pay are based on the assumption of a 30 year fixed-rate mortgage, with a loan for 90% of the sales price (i.e., 10 percent down payment). The interest rate is an average of the 30-year fixed effective rate from Freddie Mac's Primary Mortgage Market Survey during that quarter. Taxes and insurance are based on metropolitan estimates of tax and insurance rates from the most recent American Community Survey. Mortgage insurance is not currently a component of the HOI.
The HOI is the share of records in a metropolitan area for which the monthly income available for housing is at or above the monthly cost for that unit.

Federal Reserve Bank of Boston`s Housing Affordability Measure

There is no proper information found to understand how this measure is constructed.

According to the Policy Report 1-19 published by the Boston Fed in April 2019 and titled "The Growing Shortage of Affordable
Housing for the Extremely Low Income in Massachusetts", there is a measure of housing affordability for the rental segment.

From this publication, the following explanation is taken: The measure of the cost burden, or rental affordability, identifies housing costs relative to total annual household income. For example, if a household spends 30% or more of its total annual household income on annual gross rent, the household is termed “rent burdened” (Watson et al. 2017). A household that spends 50% of more of its income on rent is referred to as severely rent burdened". The common measure for affordable rental supply—affordable and available (AA)— determines a rental unit’s affordability regardless of whether the household living in the unit can afford it based on the 30% measure.

According to the discussion paper “The Housing Bust and Housing Affordability in New England: An Update of Housing Affordability Measures”published by the Federal Reserve Bank of Boston in June 2010, the components of the measure were housing income adequacy ratio and housing burden. Their respective definitions were explained as follows.

Housing income adequacy ratio:

"This is the ratio of median annual household income to the minimum annual income needed to afford the median-priced rental or owner-occupied unit. It measures whether the median household’s income is sufficient to allow that household to afford the typical house or apartment in its geographic area. It reflects the potential of the median household to obtain housing given current market conditions".

Housing burden:

"This is the ratio of the reported costs of owning or renting a housing unit to reported household income. It measures what households spend as a percentage of their income. This is, the ability of households to bear housing costs based on income from all members and all sources (such as wages, pensions, and income transfer payments)."

Summary

Within the first hour, we have been able to understand how two of the three indexes are constructed and how to interpret their scores. Further research is needed to obtain information concerning the methodology behind the Federal Reserve Bank of Boston`s Housing Affordability Measure and to analyze its construction.

Details on our recommended research path have been provided in our proposal below.


Research proposal:

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