Housing Affordability Index

Housing affordability determines whether the median household can afford the median home. When monthly principal and interest payments exceed 35% of median household income, demand collapses. Prices peak, inventory builds, and decline follows. Affordability indices are leading indicators of housing corrections, signaling distress 6–12 months before prices fall.

Key takeaways

• Monthly P&I payment should not exceed 20%–25% of gross household income; anything above 30% is unsustainable.
• The National Association of Realtors (NAR) Affordability Index fell to 85 in 2022 (100 = equilibrium), the lowest since 1985.
• When affordability index <85, demand is severely constrained; price declines are likely within 12 months.
• The relationship between affordability and price growth is inverse: tight affordability = slower demand = softer prices.
• Affordability is a lagging indicator of rate shocks and leading indicator of demand collapse.

The affordability index: definition and calculation

The NAR Affordability Index measures the ratio of median home price to the price a median household can afford given prevailing mortgage rates and income.

Formula:

Affordability Index = (Median Home Price / Affordable Home Price) × 100

Where Affordable Home Price is the price a median household can afford at prevailing rates and income.

Calculation of affordable price:

1. Median household gross income: $75,000 (example; varies by metro).
2. Available for housing: 28% of gross income (standard mortgage underwriting).
3. Annual housing budget: $75,000 × 0.28 = $21,000.
4. Monthly housing budget: $21,000 / 12 = $1,750.
5. Mortgage payment at current rates: Principal + interest (P&I) only (does not include taxes, insurance, HOA).
6. At 7% interest rate: A $1,750 monthly P&I payment on a 30-year mortgage supports a loan of ~$245,000.
7. With 20% down: A $245,000 loan represents a home price of $306,000.
8. Affordable home price: $306,000.

If the median home price is $400,000:

Affordability Index = ($400,000 / $306,000) × 100 = 130.7

An index of 130 means the median home price is 30.7% above what the median household can afford. Demand is strained.

Historical affordability and price cycles

1985–2000: Affordability index averaged 95–115. Housing was broadly affordable. Price growth was steady, 2%–4% annually.

2000–2003: Index ranged 90–105. Post-dot-com recession, prices held up because rates fell and affordability remained reasonable.

2004–2006: Index spiked to 115–135. Prices were rising faster than incomes. Affordability deteriorated sharply. Yet demand remained strong due to:

• Exotic mortgages (ARM, Alt-A, interest-only loans).
• Loose underwriting (stated income, minimal down payment).
• Belief that prices only rise (momentum investing).

By 2006, index peaked at 135. Prices had gotten ahead of what median households could actually afford, but credit availability masked the problem.

2007–2009: Index fell back to 110–120 as prices declined. Even as prices fell 15%–20%, affordability worsened because rates stayed high and incomes were stagnant (or declining due to recession).

2010–2019: Index improved to 90–110 as prices recovered slowly and rates declined. The market found equilibrium.

2020–2021: Index fell to 85–95 as prices soared and rates remained low. Strong demand drove prices above historical norms, but affordability was sustainable because rates were 3%–4%.

2022–2024: Index spiked to 110–135+ (worst since 1985) as rates jumped to 7%+ and prices held sticky. Monthly P&I on a median home exceeded 35% of median income in many metros.

The affordability shock of 2022–2023

The 2022 rate shock created the worst affordability crisis in four decades.

January 2022:

• Median home price (U.S.): $400,000
• Mortgage rate: 3.0%
• Monthly P&I on $320,000 loan (80% LTV): $1,346
• Median household income: $75,000
• P&I as % of income: 1,346 / 6,250 = 21.5% (affordable)
• Affordability index: 95 (equilibrium)

October 2022:

• Median home price: $410,000 (prices had not fallen much yet)
• Mortgage rate: 7.0%
• Monthly P&I on $328,000 loan (80% LTV): $2,181
• Median household income: $75,000 (stagnant)
• P&I as % of income: 2,181 / 6,250 = 34.9% (unsustainable)
• Affordability index: 130+ (severe stress)

In 6 months, the monthly P&I payment increased $835 (62%) for the median household. Millions of buyers were priced out. Demand collapsed.

December 2023:

• Median home price: $395,000 (slight decline)
• Mortgage rate: 6.7%
• Monthly P&I on $316,000 loan (80% LTV): $2,105
• Median household income: $75,000
• P&I as % of income: 33.7% (still unsustainable)
• Affordability index: 120+ (still severely stressed)

Affordability began to improve only in 2024 as rates declined from 7%+ to 6%+, but remained historically poor relative to 2010–2021 levels.

Affordability by metro: divergence

Affordability diverged sharply by metro:

Best affordability (index <90):

• Buffalo, Cleveland, Pittsburgh: index 60–75 (very affordable; weak job markets).
• Detroit, St. Louis: index 75–85.

Moderate affordability (index 90–110):

• Minneapolis, Denver, Chicago: index 100–110.
• Dallas, Austin: index 105–120 (despite boom, job growth supported affordability better than prices suggest).

Poor affordability (index >120):

• San Francisco, New York, Los Angeles: index 140–160+ (prices far above what median household can afford).
• Phoenix, San Diego, Seattle: index 120–140 (recovered from pandemic boom but still tight).

In metros with poor affordability, demand is severely constrained. Prices can decline 15%–25% and still leave affordability stretched.

The demand destruction mechanism

Tight affordability destroys demand through multiple channels:

1. First-time buyers priced out: Millennials saving for down payments find the goalposts moving faster than savings accumulate. Homeownership rates fall.
2. Trade-up buyers stuck: Homeowners with 3% mortgages cannot afford to sell and upgrade (the payment on a new home at 7% is 50%+ higher, consuming the equity gain).
3. Investor demand evaporates: Cap rates of 4.5%–5.5% do not pencil when cap rates are <4% (yield <Treasury yield) and affordability is terrible.
4. Rent-vs.-buy math inverts: Renting becomes cheaper than buying (at current prices and rates). Renters stay renters.

In 2022–2023, these mechanisms reduced home sales volume 50% year-over-year in some metros. Affordability indices approaching or exceeding 120 preceded demand collapse.

Affordability and price decline lag

Affordability is a leading indicator of demand collapse and a coincident (or slightly leading) indicator of price decline.

Lag sequence:

1. Month 1–2: Affordability deteriorates sharply (rate shock or price surge).
2. Month 3–6: Buyer activity declines; sales volume falls; inventory begins to build.
3. Month 6–12: Prices decline as sellers adjust expectations; months of supply rises.
4. Month 12–24: Full price correction takes hold; distressed sales emerge.

In 2022:

• Affordability crashed in March–June.
• Sales volume fell sharply by June–August.
• Prices peaked in June–July and began declining in August–September.
• Full correction (15%–30%) played out through 2023.

Investors who tracked affordability indices in Q2 2022 (when they spiked to 120+) could have exited before September peak or reduced leverage in July–August.

Using affordability to time the cycle

Sell signal:

• Affordability index >120 nationally; >130 in prime metros.
• P&I payments exceed 35% of median income.
• Sales volume declining 30%+ year-over-year.
• Months of supply rising above 5.

This combination signals late-cycle stress. Correction is likely 6–12 months out. Reduce leverage or exit.

Hold/neutral signal:

• Affordability index 95–115.
• P&I payments at 20%–30% of median income.
• Sales volume stable year-over-year.

Buy signal:

• Affordability index <90.
• P&I payments below 20% of median income.
• Prices have fallen 20%–30%.
• Unemployment elevated; wage growth weak but stabilizing.

The affordability-cap rate linkage

Affordability and cap rate spread are correlated but not identical signals.

2004–2006: Cap rates compressed, affordability worsened, but demand remained strong (credit availability masked affordability stress).

2022–2023: Cap rates expanded, affordability worsened, and demand collapsed (rates rose, prices held, both tightened affordability).

The key difference: in 2004–2006, credit expansion masked affordability; in 2022–2023, credit contraction compounded affordability pain.

Affordability decision tree

Related concepts

• Leading Indicators of a Housing Correction
• Cap Rate vs Treasury Spread
• Mortgage Delinquency and Default

Next

Affordability tells you when demand is constrained. The final article completes the picture: what happens after demand crashes and prices fall—the delinquency and default pipeline that drives the correction forward.