This time mortgage requirements are stricter, down payments are higher, and a tight supply is supporting home prices
The real-estate market is the most active its been since 2006, just before the housing market corrected around the world contributing to a global recession. Yet in nearly every meaningful way, today’s real estate market is the opposite of the previous boom.
In 2004 to the summer of 2007, home buyers were trading up to bigger, more expensive houses after barely a year or two. Many buyers purchased with small down payments, or no down payment. When housing prices stopped rising, the market collapsed. By 2009, many recent home buyers and those that refinanced and pulled out cash were upside down and short-selling their homes.
Now housing demand is stronger than ever. Buyers have higher credit ratings than ever before, and they are purchasing with much larger down payments. Most purchases are 20% or more down, and many are larger down payments and all cash purchases. This means not only are the interest rates the lowest in history – homes have the most equity in decades.
In 2020, sales of previously owned U.S. homes surged to their highest level in 14 years, and many economists forecast sales to rise again this year.
In 2002 to 2007, loose mortgage-lending standards enabled borrowers with poor credit histories to purchase homes beyond their means, sometimes with mortgages that required low or even no down payments. Too much new construction led to an oversupply of houses. Financial firms packaged these high-risk mortgages as securities and sold them to investors. When more homeowners started defaulting on their mortgages, lenders suffered large losses and the security insurance agencies defaulted on their guarantees to the investors. This collapsed the entire financial system beginning in August of 2007. Between 2006 and 2014, about 9.3 million U.S. households went through foreclosure, or sold in a short-sale for less than the loan balance owed. The current housing boom is far more stable than the last one and poses fewer risks. There are more barriers to purchase a home today.
Most real-estate analysts agree that the pandemic helped ignite the current boom as some urbanites looked to leave crowded cities like New York and San Francisco for cheaper cities or for more space in the suburbs while working from home. When lockdowns began lifting last year, home sales took off. June sales surged nearly 21% over the prior month, the biggest monthly increase on record going back to 1968. That milestone lasted only a month, when July sales topped it, and rose almost 25% from June.
“the Covid shutdown” has changed the way we think about where we live, and why we live there – and where we work, and how we work. And there are a number of longer-term trends are at play that should keep the housing market steady, even after Covid-19-related demand fades.
Millennials, the largest living adult generation, continue to age into their prime homebuying years and invest savings to purchase homes. At the same time, the market is critically undersupplied. New-home construction hasn’t kept up with household demand, and homeowners are holding on to their houses longer. Buyer demand exceeding supply of homes translates to upward trend in prices. This is basic economics.
Mortgage lenders, meanwhile, are maintaining tight standards. Buyers are drawn to the market by historically low interest rates, not by easy access to credit. Rising home values also mean that even if homeowners have an issue with affording their mortgage payments, they can simply sell their homes for a profit. Financial firms are still packaging mortgages as securities, but the vast majority of those mortgages today have government backing, tighter qualifying conditions, and much stronger loan to value position.
The biggest winners in today’s real estate market boom? People who already own homes. They gained a collective $1.5 trillion in equity in 2020 from a year earlier. They have also saved money by refinancing their mortgages at record low rates. Many have started renovation projects increasing their home’s value even more, or purchased a vacation home with 20% or more down payment.
The S&P Homebuilders Select Industry Index is up 96% over the past year, outpacing the S&P 500’s 59% gain. Between July and December, eight of the 30 largest U.S. mortgage lenders announced plans to go public.
Homebuyers trying to purchase their first home have rarely found it more difficult. U.S. house prices soared 10.8% in the fourth quarter from a year earlier on a seasonally adjusted basis – the biggest annual increase in data going back to 1992. The median U.S. home purchase price rose above $300,000 last year for the first time. And nearly one in four U.S. home buyers between April and June bought houses priced at $500,000 or more.
Although first-time home buyers are struggling to afford down payments, the homeownership rate stood at 65.8% in the fourth quarter of 2020, up from 63.7% in the fourth quarter of 2016, according to the U.S. Census Bureau.
The housing market’s biggest near-term concern is rising mortgage interest rates – 30 year fixed rates recently increased from 2.75% to 3.25%. With bond yields rising as investors anticipate a post-Covid rebound, many economists expect mortgage rates to continue creeping upward this year.
Some of the home sales in the past year were likely sales that would have happened in the next few years but were accelerated due to reaction from the change in working options due to the government reaction to Covid-19. That could bring a slight slowdown in demand going forward. Some people who are currently working from home are also likely waiting for their companies to decide on future remote-work policies. They might choose to stay in their current home if they are required to commute to the office daily in the future.
The housing markets in New York City and San Francisco, two of the country’s priciest areas, slumped last year as some residents moved away and the pace of people moving into those cities slowed. In San Francisco, the median sale price in January declined 1.9% from a year earlier, even though U.S. home price increases averaged over 10%. In Sacramento, Calif., an influx of buyers from the San Francisco Bay Area helped push up that median sales price 21.3% in January from a year earlier.
Firms lending on all these home purchases are thriving. In 2020, mortgage lenders had more demand than they could handle. Homeowners rushed to refinance at lower interest rates and homebuyers rushed to the market. Mortgage originations rose to a record high in the fourth quarter. And 70% of those mortgages went to borrowers with credit scores above 760.
New-home construction hasn’t kept up with demand in recent years, as builders took years to recover from the financial crisis and faced shortages of land and skilled labor. Those shortages and rising material costs continue to hinder builders as they increase production. While housing starts rose in 2020, new-home construction per U.S. household in December was still more than 20% below its average level in the late 1990s.
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