Risks to economy come as cheaper homes sold on more credit
Market Watch - Published: Oct 17, 2016 12:35 p.m. ET
Ever since the shock of the financial crisis ebbed and buyers began to return to the housing market, one truth has dominated: mortgage lending is tight.
But is it?
It’s true that only the borrowers with the highest credit scores get home loans now. So much lending to people with higher credit scores and so little to those on the lower end of the spectrum has shifted the average FICO score up about 40 points since before the bubble burst.
But measured in another way, lending is shockingly loose. And, according to one economist, that tells us a lot not just about the housing market, but about the economy as a whole.
The 20% down payment may linger in Americans’ imagination, but it’s even less real today than Jimmy Stewart’s small-town banker from 1946. American homeowners, particularly those at the lower end of the market, are increasingly leveraged to pay for their houses, says Sam Khater, deputy chief economist at data provider CoreLogic.
In fact, owners of entry-level homes, those in the $150,000 to $300,000 range — have more debt and less equity now than they did in 2005, at the height of mortgage mania.
For Khater, that says less about credit markets and more about another defining feature of the post-recession housing market — its lack of affordability.
“We have our eye on the wrong ball,” he told MarketWatch. “What I worry about is the leverage not from a default perspective but from an affordability perspective. Demand for credit has been weak. But the much bigger issue is the supply of housing, not supply of credit.”
There’s been a lot of discussion about the affordability crunch, how rent is too high, and how home builders have targeted the higher end of the market since the end of the recession. But that hasn’t resulted in any new inventory.
Home builders are selling fewer and fewer homes in the lower-end categories as the recovery drags on. They built more than four times as many homes in the $750,000 and above price range in the first half of this year than those priced under $125,000.
Sales of existing homes aren’t doing much better: those in the $0-100,000 range slid 20% from August 2015 to 2016, and in the $100-250,000 range were also down double digits:
But highly-leveraged entry-level borrowers isn’t just a signal of problems in the market, Khater says. It’s also problematic on its own.
For one thing, borrowers who stretch more to pay for housing have much less to spend on other things, and that suppresses economic growth, he points out. “The fact that the market isn’t providing enough affordable housing isn’t just a real estate issue, it’s an economic issue.”
The Pew Charitable Trusts investigated household expenditures in a report released in March. Using Labor Department data, Pew found that expenditures are back to pre-recession levels while incomes are not, and that families in the lower one-third of income brackets spent 40% of their income on housing, leading them to spend “considerably less than their middle- and upper-income counterparts on discretionary items, such as food away from home and entertainment,” Pew noted.
Also, as homeowners borrow more and more to buy homes, they become more and more sensitive to price changes, Khater notes. While it’s impossible to say where we are in the housing market cycle, it’s certainly not the beginning, and prices in several metros have long since surpassed the highs they first set 10 years ago.
“It’s one thing to be leveraged at the beginning of a run-up in home prices. It bears more risk when you’re at the top of pricing,” he said. “I don’t know where we are but I do worry that if we have this much leverage at this part of the real estate cycle that we might be setting up for turbulence in the near future.”
Khater also thinks the affordability hump will serve as a speed bump for the entire housing market. “As home prices continue to move up, there are fewer and fewer borrowers who are able to participate in the market,” he said. Sales have begun to falter – but price growth marches on.
“At some level, we’re sort of running out of customers,” Khater said.