CoreLogic measures housing affordability in four different ways, the methodologies of which are detailed below:

• The ratio of median dwelling prices to median gross annual household income.  Utilising median household income data which has been modelled by the Australian National University Centre for Social Research and Methods (ANU) and median dwelling price data from CoreLogic we determine the ratio of dwelling prices to household income over time.  For example, a dwelling price to income ratio of 5 implies that the typical household will spend five times their annual gross income to purchase the typical dwelling outright within the same region.
• The number of years of gross annual household income required for a 20% deposit.  Using the ANU's modelled household income data we provide a measure of affordability for those households that don't yet own a home.  This analysis looks at how many years of a household's annual gross income is required to pay a 20% deposit, based on the median priced dwelling.  For example, a city where the median dwelling price is $600,000, a 20% deposit would equate to $120,000.  If the median household income was $100,000, the deposit would comprise 1.2 years of the gross annual income for the household. 
• The proportion of household income required to service an 80% loan to valuation ratio (LVR) mortgage.  This measure is based on mortgage serviceability and is more applicable for households that already servicing a mortgage. Assuming the owner has borrowed 80% of the median selling price (i.e. they had a 20% deposit) and are making their mortgage payments based on the discounted variable mortgage rate for owner occupiers (4.5% as at June 2017), we measure the proportion of annual household income required to service the mortgage.  For example, for a region with a median dwelling price of $600,000, the typical loan amount based on an 80% LVR would be $480,000.  Based on the current discounted variable mortgage rate and annual household income of $100,000, the household would be dedicating 32.0% of their gross annual household income to servicing the mortgage.
• The proportion of gross annual household income required to pay the rent.  Utilising household income data and the median weekly rent we measure what percentage of household income is required to service their rental payments.  For example, a household with $100,000 annual gross income who is paying $600 per week in rent would be dedicating 31.2% of their annual gross household income to pay their rent.

The latest data to June 2017 indicates that, despite the cash rate remaining stable at record lows, housing affordability has generally worsened over the most recent quarter.  The changes in affordability at a national level are detailed below: 

• Dwelling price to household income ratio The national dwelling price to household income ratio was recorded at 6.8 in June 2017, with a higher ratio for houses (7.0) compared with units (6.3).  The ratio increased over the quarter for houses and units however, 15 years ago the ratios were much lower at 4.5 for houses and 5.1 for units.  The measure for houses is currently at an historic high while for units it has moderated slightly from a high of 6.5 in early 2015.
• Years of household income required for a 20% deposit  A 20% deposit was equivalent to 1.36 years of gross household income at the end of June 2017, with the figure recorded at 1.40 years for houses and 1.26 years for units.  At the same time in 2002 it took 0.92 years to save a 20% deposit, 0.89 years for houses and 1.02 years for a unit.  As the cost of housing has increased and household income growth has slowed it has become increasingly challenging for some segments of the market to raise a 20% deposit which has required a longer period of savings in order to enter the housing market.
• Proportion of household income required to service an 80% LVR mortgage  At the end of 2016-17 financial year it took 36.2% of the median gross annual household income to service a mortgage, with the proportion higher for detached houses (37.2%) and lower (33.7%) for units.  Although mortgage rates have fallen over the past year, the ongoing increases in dwelling prices and low level of household income growth means serviceability has deteriorated.  Despite the higher reading over the June quarter, mortgage serviceability is currently at similar levels to what was recorded in early 2004, highlighting how lower interest rates have made it easier for home owners to service and pay off their mortgage debt.
• Proportion of gross annual household income required to rent a home  Over the past 15 years there has been very little movement in the proportion of household income required for rent.  This highlights that increases in rental costs are constrained by movement in household incomes.  At the end of June 2017, 27.6% of the median gross annual household income was required to pay rent with the figures similar for houses (27.2%) and units (27.6%) across the country.  The data also highlights that despite historic low interest rates, it generally remains cheaper to rent than to take out a mortgage in many areas.

For the purposes of this analysis we have just focussed on two metrics, the dwelling price to household income ratio and the proportion of household income required to service an 80% LVR mortgage.

Dwelling price to household income ratio

The above charts highlight how much of the deterioration in housing affordability, based on a dwelling price to household income ratio, is occurring in Sydney and Melbourne.  Five years ago Sydney's ratio was 6.7 times and Melbourne's was 6.5 times, fast forward to June 2017 and the ratios sit at 9.1 times and 7.5 times respectively.   Over the past five years, median dwelling prices in Sydney have increased by 59.6% and Melbourne prices are 29.9% higher.  Meanwhile, Sydney household incomes are 18.4% higher and Melbourne household incomes are up 13.2%.  Outside of Sydney and Melbourne, most other capital cities have actually seen very little change in affordability over the past five to ten years based on this metric.  This highlights that while deteriorating housing affordability is viewed as a national problem, Sydney and Melbourne (where 40% of the population live) is very much the focal point.
 

Proportion of household income required to service an 80% LVR mortgage  

This analysis takes into consideration mortgage rates and the impact of changes in them over time.  Keep in mind that this analysis relates more to the cost of servicing a mortgage so is related more so to someone that already owns a property whereas the price to income ratio is more about the cost of entering the housing market. This analysis highlights that not only is it more expensive to enter the market in Sydney and Melbourne but once you own a home the mortgage currently eats up a much larger chunk of household income than it does elsewhere.  Mortgage rates for owner occupiers are at historic lows however, someone buying under these conditions would still be spending 48.4% of their gross annual household income to service that debt in Sydney and 39.9% in Melbourne.  Of course, these figures have been higher peaking at 54.4% in Sydney in March 2008 and at 49.1% in June 2008 in Melbourne.  

Importantly, in March 2008 mortgage rates sat at 8.7% and in June 2008 they were 8.85% compared to rates of 4.5% in June 2017.  Outside of Sydney and Melbourne the cost of servicing a mortgage is much lower but again, it is important to remember that mortgage rates for owner occupiers are at historic lows and likely to start moving higher at some stage, potentially in 2018 or 2019.  

The data presented highlights that housing is expensive across the country and that over recent years housing affordability has deteriorated however, much of that deterioration has occurred in Sydney and Melbourne where the pace of capital gains has far exceeded growth in household incomes.  The latest CoreLogic Home Value Index data shows that dwelling value growth is slowing however, moderate falls are unlikely to result in a significant improvement in housing affordability.  As mentioned, despite mortgage rates for owner occupiers tracking at record lows, servicing a mortgages is taking-up a large proportion of household incomes in Sydney and Melbourne.  Should mortgage rates start to rise without a commensurate rise in household incomes it will mean that households will have to spend an increasingly greater proportion of their household income to service their mortgage.  If that was to occur it would likely impact on other areas of the economy, particularly with regards to areas of expenditure such as retail trade.

This article first appeared on ww.corelogic.com.au