Saturday, November 22, 2008

Changes in the Relative HAI. Do they signal anything?

The National Association of Realtors (NAR) publishes the Housing Affordability Index (HAI). The NAR provides the methodology used to calculate the HAI. Basically, it is equal to the ratio between the median household income and the income needed to qualify and purchase a median priced existing 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 percent down payment. For example, a composite HAI of 120.0 means family earning the median family income has 120% of the income necessary to qualify for a conventional loan covering 80 percent 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 percent of the home price and it assumes a qualifying ratio of 25 percent. That means the monthly P&I payment cannot exceed 25 percent of the median family monthly income.

The NAR publishes three different HAI indexes. There is one for adjustable rate mortgages, one for fixed rate mortgages and a composite series for all mortgages. The series are available at the NAR website. In the figure below, I have plotted the ratio of the ARM HAI to the Fixed Rate HAI. The relative attractiveness of adjustable rate mortgages over fixed rate mortgages should be positively related to this relative ratio index.


One reason for taking out an ARM rather than a fixed rate mortgage is that given the lower initial rate the borrower can qualify for a larger mortgage. As indicated in the above diagram, the relative attractiveness of ARMs increased significantly in the first half of the 90s. It then fell and remained relatively constant until about 2004 with the ARM HAI about 10 percent above the fixed rate index. That relative attractiveness was largely eliminated by the mortgage crisis, with the relative ratio falling to 1 in 2007. The changes in the indexes do seem to indicate that ARMs are not as attractive as they once were.

There does seem to be a more interesting story waiting to be told. Both of the drops in the relative ratio were coincident with the flattening of the yield curve in 1995 and 2005.

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