In the past, interest rates and the housing market went hand and hand. As tighter lending standards decrease the number of applications, even low rates cannot help.
Mortgages and home prices move in sync. As mortgage interest rates drop, home prices begin to rise. This happens because of access to capital. Lower interest rates result in lower monthly payments. While this is not rocket science, this relationship becomes more interesting as interest rates remain fairly low, but mortgage requirements become tougher.
Mortgages of the Past
After 9/11 the Federal Reserve lowered interest rates to their lowest levels in recent history. This spurred a run on residential real estate that has not been seen in many years. Unfortunately, this also spawned many fly-by-night lenders and mortgage brokers looking to make a quick buck. In order to compete many lenders loosened their standards and opened the real estate barn door as wide as they could.
Inevitably, everyone charged in. Homeownership reached its highest levels ever at the boom, thanks to the wide access to mortgages. While some may argue that many people had mortgages and should not have, a pleasant side effect to the more lax mortgage standards was the shear amount of wealth creation for any person brave enough to fill out a mortgage application.
Predictably, the mortgage market hit a tipping point. A little known term before 2006, subprime mortgages acted as the pebble that started a ripple of waves that looks to be turning into a tsunami in many markets. By mid-2007 the pendulum had decidedly swung the other way. Lax underwriters did not just take a financial hit; many of them went out of business. Even the most stalwart of firms took massive write-downs on unwise loans, resulting in sweeping changes in lending practices.
Mortgages of the Present
As the saying goes, “Once bitten, twice shy,” mortgage lenders ramped up requirements so fast consumers did not know what hit them. Some consumers had loans approved, only to be denied several days later. Others saw their interest rate skyrocket. Still others were asked to put more money down (in many cases significantly more).
Today, interest rates still represent historical lows, but obtaining a mortgage has become harder then ever. First, borrowers with less than stellar credit have been blacklisted. People, who would have qualified for subprime loans a year ago, now are told not to even consider applying. Second, borrowers looking for loans on substandard properties have been increasingly finding it harder to qualify for conforming loans. Lastly, borrowers applying for loans in “at-risk” areas, areas that represent the largest price declines in the U.S., will have to come up with 25-30% of the purchase price under new bank standards. A borrower purchasing a $200,000 home, who would normally put 10% down ($20,000), is now being asked to put up to $60,000 down! Even for the most conscious saver that is a tall task.
This new variable means that real estate prices may not yet be at their bottom. As lenders make it tougher for buyers to obtain a loan, buyers’ ability to pay higher asking prices will be constrained. This will mean longer time on the market for sellers and probably a lower selling price. Sellers can help alleviate this problem a bit by offering seller financing. As lenders get tighter, expect to see more offers with sellers offering to finance a borrower’s downpayment or some other creative financing structures.
