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After several years of monitoring delinquency and losses, it’s important for credit union management to adjust lending criteria back to “normal” and to get loan underwriters and loan officers out of a recessionary mindset.
That’s not to say, however, that the recovery will be smooth sailing. The competitive landscape is as challenging as it has ever been due to high liquidity, high unemployment, and low mortgage rates.
Therefore, lenders must continue to monitor home prices, rates, inventory, new home starts, and inflation closely for signs of stress in the housing market.
Consider the example of a young couple buying their first home in Colorado Springs for $200,000. With a Federal Housing Administration (FHA) loan and 3% down, they’ll finance $194,000 for as low as 3.25% for 30 years fixed. Their principal and interest payment will be about $845. With an annual income of $48,000, their principal and interest will be 21% of their income.
Let’s assume that in three years this couple decides to move to Denver and they put their home on the market. They simply want to sell the home for what they paid for it.
The economy has continued its slow improvement, unemployment has finally declined to less than 6%, and the Federal Reserve has slowly eased the monetary measures it used from 2009 through 2013 to keep the economy afloat. Thus, the rate for a 30-year, fixed-rate mortgage is now 5.25%.
The couple who wants to buy the home is in a similar financial situation the current owners were when they purchased it in 2012. The new buyers have an annual income of about $54,000, which takes into account that the average income has risen 3% a year between 2012 and 2016.
With a 3% down FHA loan, they will pay principal and interest of approximately $1,071 and have a payment ratio of 24% with a $200,000 purchase price. The payment, with a two percentage point rate increase, has risen 27% (for this example, I have excluded any taxes and insurance).
Any increase in mortgage rates from today’s historically low levels could have an equally historic impact on pricing and housing demand. The increases in mortgage rates that occurred between 1979 and 2007 did not trigger a drop in housing values because:
- Variable-rate, interest-only, and negative-amortization loans allowed buyers in the early 1980s to get into homes with lower payments;
- Strong inflation caused incomes to increase in step with periods of very high rates;
- Mortgage brokers and bankers pushed variable-rate products after the refinance boom of 2003 to keep loan volumes high; and
- Pick-a-payment loans and stated-income loans allowed people who had no business buying homes to do exactly that between 2004 and 2007.
After the Dodd-Frank Act, it’s arguably going to be impossible for “innovative” products like these to carry the housing market.
In my example, for the new buyers of that home to have the same payment-to-income ratio the previous owners had, they would have to finance no more than $171,000.
What do you think is more probable: That they’ll come up with $23,000 more as a down payment, or they’ll offer about $176,000 for the house?
There’s a third scenario: The buyers (and all buyers of homes at that higher rate) will have to devote a larger portion of their income to housing. Is that sustainable?
The moral of the exercise: Be cognizant of opportunities in home equity and mortgage lending, but monitor home prices, rates, inventory, new home starts, and inflation closely for signs of stress in the housing market.