Question of the week: I read we are approaching another housing bubble, is this true?
Answer: It seems a recent fad amongst financial reporters is to dissect the rise in home prices and explain why bubble conditions are in effect similar to 2008, especially in areas like Orange County where the median price is just below the all-time high of the summer of 2007.
There was an email circulating in our office from a business writer whose premise is that another housing crisis is “just around the corner” and a few clients have forwarded me other columns and articles they have received with similar content. And of course there is “The Big Short” showing at a cinema near you.
The premise for the potential large drop in housing prices is that home prices have been climbing fairly steadily for the past several years, that Fannie Mae has come out with a new program this is essentially a FHA look alike for low income and minority borrowers, and that, well we need something to write about.
My response has been that while we may experience a market correction—which in much of California can be defined as the market being flat or prices declining—any correction will be somewhat soft, not prolonged and not for the reasons many of those calling for a “crisis” are using for their prediction. (By the way if there is any correction those calling for a crisis will be out with I-told-you-so columns.)
A quick look back at the housing market collapse that started in February 2007: The initial problems began in the sub-prime mortgage market, which at the time was about 10% of the total mortgage market. As the sub-prime lenders had issues getting capitalized on Wall Street, i.e. could not sell their mortgages to investors, they began to fail. At first it appeared that the issue would be confined to the sub-prime market and lenders, but then investors began taking a closer look at non sub-prime jumbo loans and then conforming loans being sold by Fannie Mae and Freddie Mac. What the investigations showed was that many of these loans were approved and funded under the same guidelines, or lack thereof, being used by the sub-prime lenders. The big exception being that the loans, and the securities that we sold that consisted of those loans, were being sold to investors as prime investments, getting high ratings from the agencies.
Loans that were up to 80% of the value of a property, with no mortgage insurance but a second on the property taking the loan to value to 100% of the property value, were being approved and funded by Fannie and Freddie with no income verification, no funds needed to close and often no appraisal being required. Rated at A++ were mortgages with a credit report showing a score over 680, a place of work and stated income.
With millions of homebuyers purchasing new homes with conforming mortgages using very lax underwriting standards, and millions of homeowners taking out equity using those same standards, the housing market was being financed by a wink and a nudge. This created a larger market of loan eligible homebuyers such that buyers far exceeded sellers and market conditions reacted as expected with skyrocketing home prices.
Once the bottom card was jiggled the entire house of cards fell down.
Fast forward to our current market and state of the industry. Since 2008 the mortgage industry has retrenched such that underwriting guidelines today strongly resemble those of 1988, except a bit stricter due to unmovable criteria. The similarities to 30 years ago and today: if you want a mortgage you have to prove you have the income to support the housing payment plus your other debt. The dissimilarities: we now have FICO scores that provide no-go barriers for getting a loan if your score is too low (as well as tiered pricing so the lower your eligible score the higher your rate), prior to FICO underwriters would grade the reports and determine if a borrower’s past transgressions were excusable and approvable for a mortgage. Funds to close are now scrutinized more than ever, no more bringing cash into the bank, converting to a cashier’s check and bringing that to escrow; today all funds for a transaction have to be meticulously accounted for and traced. Appraisals are no longer performed by the local professional the mortgage originator knew, coached the Little League team with or sat behind in church; today mortgage originators are prevented from having any direct contact with an appraiser, all orders must go through an approved Appraisal Management Company and their selection of an appraiser is random from their pool.
So in most respects the criteria for getting a home loan are tougher today than they were before automated underwriting and the expansion of Fannie Mae and Freddie Mac.
This is important when it comes to predicting the future of the housing markets and whether or not we will see a repeat of 2008 because it means the quality of risk for homeowners who have mortgages is much higher than those who obtained loans in the years preceding the market meltdown. Since 2008 every borrower has shown the ability to pay for their mortgage and debts, has “skin in the game” with down payment funds from themselves or a relative and have higher credit scores.
Because of the quality of qualifications of those who have obtained loans in the past seven to eight years the risk of foreclosure is mostly employment risk. As long as borrowers have their jobs they are going to be making their payments. Sure some will over extend themselves with other credit, but if their income is the same as it was when they obtained their mortgage they should be able to continue to pay the mortgage and put their other credit at risk.
The other risk that is still present from the pre-collapse era is interest rate and payment risk to those with adjustable rate mortgages, either a first mortgage that is an ARM or was a hybrid-ARM (3, 5, 7 year fixed rate then adjustable) or those with large equity lines. As rates increase these homeowners may face difficulty making payments if their incomes have been stagnant.
Should a homeowner have financial difficulty because of rising prices they have equity in their homes, making it possible for them to sell or refinance to a lower and more manageable payment.
Finally, most homeowners learned painful lessons from the 2007 to 2009/10 period. Many had homes upside down or saw neighbors, friends and family members lose their homes. With those memories still fresh mortgage applicants we have spoken to are almost solely looking for 30 or 15 year fixed mortgages and buying homes with payments they can afford on their current incomes.
Will the housing market continue to grow as it has the past few years? Probably not, at some point we will see a slow-down, and perhaps a bit of correction—more in some regions than others. Will we see a collapse of the housing market that we experienced less than a decade ago? In my opinion no, the fundamentals of the underlying mortgages supporting the housing market are too strong to enable a free fall similar to what we experienced.
I mentioned it a few weeks ago, if you have the opportunity go see “The Big Short.” Based on a book by Michael Lewis, the movie provides a very accurate look at the back-side of the mortgage industry and how the bubble that burst was created. As well it is extremely well made with great writing and acting.
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Our rates this week have been impacted by three major factors: stocks, prices and homes. Stocks continued their slide early in the week, hitting lows on Wednesday, that began as we turned the calendar to 2016. Push down by investors selling equities based on falling oil prices and continued concerns about China, funds in stocks have been moving to bonds, and mortgages, resulting in softer rates.
Following last week’s Producer Price Index we received the Consumer Price Index numbers for December. The CPI for all goods and services dropped 0.1% while prices rose 0.7% if food and energy are stripped from the data. Year over year total CPI is up a scant 0.1% and the core rate minus energy and food rose 2.1%. The impact of lower energy costs is impacting the economy, and helping consumers home finances as we pay less for gas and in the other parts of the country heating oil. Even without the lower energy costs however prices are not quite in range of the Fed’s target inflation rate which provides support for the Fed not engaging in another rate increase for quite some time.
The economic expansion experienced before the recession was very much driven by the housing markets. It appears that our current economic stability and avoidance of even slower growth may be due to housing as well. Existing home sales in December were 5.46 million annualized sales, the most in one month since 2006. The increase from November was 14.7%, a record month to month increase. The huge increase from November was mainly due to a lag in closings created by new mortgage regulations that took effect in October slowing the industry, but also contributed was unseasonably warm weather in much of the country. Year over year existing home sales are up 7.7%. Of concern in the report is lack of inventory, with supply at 3.9 months. If supply continues to remain tight and rates low we can expect to see more price appreciation into 2016. The news is mortgage rate unfriendly and is a cause for higher rates.
Rates for Friday January 22, 2016: Rates remain flat from last Friday, blipping back up a bit today on the housing news and rebounding stocks after blipping down a bit earlier in the week. Rates should be stable within 0.125% of their current levels for the next few weeks.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 3.625% Flat
30 year high-balance conforming 3.875% Flat
30 year FHA 3.25% *** Flat
30 year FHA high-balance 3.25% *** Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down (3.5% for FHA) with 740 FICO score for purchase mortgages. ***FHA rates have no points and credit towards closing costs, recent rate change reduces credits
It appears Southern California is getting the possible El Nino weather. Most of the rain storms have been going north to the Central Coast and Northern California which is where we need it for our water supply, while we have been dry. Will it continue? I wouldn’t mind more rain just because I like it!
With the rainy weather we have had and will have more of in the future it is a great time to look at homes to buy. For decades I have told potential buyers to go out and look during inclement weather so you can see if a roof has issues, where water puddles on a property that may cause damage, how drainage is and generally discover potential issues that you won’t notice from about March until October or November in normal years. It may rain tomorrow, put on your galoshes, grab and umbrella and go house hunting.
But before you do call me to get pre-approved!
Have a great week,
Dennis
