I know I listened in my high school economics class because I got an "A". I was there and obviously spewed back the information required of me, but, either I've forgotten a lot, or there was a lot that wasn't covered. Important terms like affordability Index and absorption rate were new to me when real estate became my career.
"A measure of the financial ability of U.S. families to buy a house. 100 means that families earning the national median income have just the amount of money needed to qualify for a mortgage on a median-priced home; higher than 100 means they have more than enough and lower than 100 means they have less than enough."
Having the definition helps tremendously to understand the 2007 St. Paul and Minneapolis Housing Market Analysis published by the Minneapolis Area Association of REALTORS®.
National median incomes for 2007 don't appear to be published yet, but the national median income in 2006 was $48,201. It's recommended one's house payment not exceed one third of your income. Divide the annual income of $48,201 by twelve to get the amount earned each month which is $4,017. Divide that amount by 3 to find what monthly payment the buyer can afford. In 2006 the person with a median income can afford $1,339 for a mortgage payment. IF the buyer had a large enough down payment the affordability of the St. Paul or Minneapolis home would go up because the payments would decrease, but most buyers in 2006 did not have down payments.
In the St. Paul and Minneapolis area in 2006, the median price of a home was $230,000. If the buyer had no down payment, the principle and interest at 6% interest is $1,380.00. Oops! That amount is already over the recommended 1/3 of income and we're not done yet. To the $1,380 is added 1/12 of the taxes and hazard insurance plus private mortgage insurance making a total payment of at least $200-300 more than $1380. That doesn't seem very affordable to me. To continue to place buyers in homes, the lenders stretched the recommended 1/3 to as much as 40-50% of one's income or with adjustable rate mortgages that would adjust to unreasonable percentages. It wasn't long before the damage was done and the real estate market blew up.
Of course, there's an actual formula to arrive at the affordability index, but the Minneapolis Area Association of REALTORS® did an awesome job of creating this chart so I didn't have to do the work. Here, in picture form, is the affordability index for the Twin Cities housing market in the last five years.
According to the MAAR report, home values outstripped household income by almost three to one from 1992 to 2005. That's a considerable increase in house prices that wasn't matched by an equal increase in income. The ceiling was hit in 2006 and buyers could no longer buy a home. As St. Paul and Minneapolis area prices have started to decrease, buyers have cautiously returned to the market.