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The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median familial disposable incomes, expressed as a percentage or as years of income. It is sometimes compiled separately for first time buyers and termed attainability. This ratio, applied to individuals, is a basic component of mortgage lending decisions. According to a back-of-the-envelope calculation by Goldman Sachs economists, a comparison of median home prices to median household income suggests that U.S. housing in 2005 is overvalued by 10%. "However, this estimate is based on an average mortgage rate of about 6%, and we expect rates to rise," the firm's economics team wrote in a recent report. According to Goldman's figures, a one-percentage-point rise in mortgage rates would reduce the fair value of home prices by 8%.
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The deposit to income ratio is the minimum required downpayment for a typical mortgage [specify], expressed in months or years of income. It is especially important for first-time buyers without existing home equity; if the downpayment becomes too high then those buyers may find themselves "priced out" of the market. For example, as of 2004 this ratio was equal to one year of income in the UK (Nottingham Trent University paper).
Another variant is what the National Association of Realtors calls the "housing affordability index" in its publications. [6]. (The NAR's methodology was criticized by some analysts as it does not account for inflation [7]. Other analysts, however, consider the measure appropriate, because both the income and housing cost data is expressed in terms that include inflation and, all things being equal, the index implicitly includes inflation[citation needed]). In either case, the usefulness of this ratio in identifying a bubble is debatable; while downpayments normally increase with house valuations, bank lending becomes increasingly lax during a bubble and mortgages are offered to borrowers who would not normally qualify for them (see Housing debt measures, below).
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The Affordability Index measures the ratio of the actual monthly cost of the mortgage to take-home income. It is used more in the United Kingdom where nearly all mortgages are variable and pegged to bank lending rates. It offers a much more realistic measure of the ability of households to afford housing than the crude price to income ratio. However it is more difficult to calculate, and hence the price to income ratio is still more commonly used by pundits.
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The Median Multiple measures the ratio of the median house price to the median annual household income. This measure has historically hovered around a value of 3.0 or less, but in recent years has risen dramatically, especially in markets with severe public policy constraints on land and development. The Demographia International Housing Affordability Survey uses the Median Multiple in its 6-nation report.
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