Mar042013

A lack of first-time homebuyers is a drag on the housing market

The foundation of any housing market is the first-time homebuyer. By definition, people buying their first home don’t have equity (free money) from a previous sale to extend their borrowing power. Without the activity of first-time homebuyers, those who own homes at the entry level (previous first-time homebuyers) can’t sell and buy a move-up property. The first level move-ups ignite a chain reaction throughout the move-up market stimulating sales across all price points. If the first-time homebuyer cohort is not active, the entire housing market seizes up, and sales volumes are low.

Recently, reports in the mainstream media are touting the increase in sales activity. While it’s true that sales volumes are off the anemic lows of the 2008-2011 era, sales are still well below the norm. From 2000 to 2006, sales in Orange County were never below 42,000 sales per year, and the average was about 45,000 per year. Based on the relative number of houses in the county, the ratio of sales to total number of homes was relatively steady. Over the last five years, sales in Orange County have hovered at around 30,000 per year. That’s about 30% less than normal, and about 10% below the average all the way back to 1988 when there were fewer existing homes.

The dramatic decline in sales is apparent in the origination figures:

The low origination volume is a problem across the board. First-time homebuyers are absent due to high debt levels with student loans and credit cards, and move-up markets are hampered by the fact that more than a quarter of borrowers are underwater. The housing market will not recover until first-time homebuyers come back in large numbers at price points high enough to lift existing loanowners above water. The federal reserve and the banks are doing their part. The federal reserve has lowered interest rates to record low levels to allow buyers to bid up prices, and the banks stopped foreclosures to restrict MLS inventory to force the few active buyers to pay more thus raising neighborhood comps. Now all they need is an improving economy and a flood of first-time homebuyers to get the housing market moving again. Unfortunately, first-time homebuyers are facing headwinds of their own.

More first-time home buyers have tough time entering the market

High unemployment for young people, strict lending standards and massive student debt loads are among the factors hurting entry-level buyers.

By Kenneth R. HarneyFebruary 22, 2013, 9:40 p.m.

WASHINGTON — Although the housing market is rebounding in many local markets, one important segment is not: First-time buyers are missing in action and represent a smaller proportion of overall sales activity than their historical norm.

Whereas first-timers typically account for roughly 40% of sales, lately they’ve been involved in about 30% to 35%, depending on the source of the data. Lawrence Yun, chief economist for the National Assn. of Realtors, estimates that there were 2.2 million fewer first-time buyers in the United States between 2008 and 2012 — a deficit of about 450,000 a year.

If it weren’t for the activity of investors, including large hedge funds, there would be no market recovery. They are stepping into the shoes of first-time homebuyers and picking up some of the slack. However, this is not without long-term consequences. The move-up market will suffer for another decade because the equity that ordinarily would have accrued to the first-time homebuyers — equity necessary to complete a move-up sale — is instead being diverted to small investors and hedge funds.

The housing market may sustain recent gains if the banks can keep inventory off the market indefinitely; however, a true sustainable housing market recovery will not happen until first-time homebuyers return in large numbers, and about 5 to 7 years later, those buyers will start making move-up sales which will make that segment of the market recover too. We’ll know when the real market recover happens when we see the chart of originations (pictured above) break out of its range and start to climb back up to the level of the 00s. So far, it’s been three full years stuck at mid 90s levels, and it’s showing no real sign of improvement, mostly due to the problems facing first-time homebuyers discussed today.

Recent surveys of Realtor members by Yun’s research team have found that first-time purchases slipped to just 30% during each of the last three months. Mortgage investment giant Freddie Mac reports that first-time buyers represented just 35.9% of loan acquisitions by the firm in 2011. Last year, the Federal Reserve found that whereas between 1999 and 2001 about 17% of 29- to 34-year-olds took out a mortgage to buy a first home, the figure plunged to just 9% during 2009-11.

Notice that they picked a stable period prior to the housing bubble as a point of comparison. The decline in first-time homebuyer participation among the 29-34 year age group is remarkable. The only reasonable explanations for this is an explosion in student loan debt and a weak job market that disproportionately impacted younger workers.

All of this represents a potentially significant issue for homeowners and sellers in the overall market. Without entry-level buyers, the housing system doesn’t work well. If there’s no one to buy moderately priced starter homes, the owners of those houses can’t sell and move up.

So what’s the problem? Where are these first-timers who should be jumping in while mortgage interest rates are near all-time lows and prices in some markets are still at 2004-05 levels? Recent economic jolts — the recession and relatively high unemployment rates for younger workers — are crucial factors. Disproportionate numbers of twenty- and thirtysomethings have moved back in with their parents or are renting with others rather than buying a house.

The big question facing homebuilders is whether or not this change is a generational change in attitude or a temporary reaction to the tough economy. If the younger generation permanently chooses the freedom of renting over the debt slavery of home ownership, the multifamily sector will do well, but the demand for new homes will sputter. At this point there is no way to know.

Tougher underwriting and qualification requirements by the banks are also important contributors. …

On top of these burdens, though, is still another financial albatross: massive student debt levels and their toxic interaction with lenders’ stringent rules on debt-to-income ratios.

Student loan debt loads have exploded in the last decade and now exceed $1 trillion, according to financial industry estimates. A Pew Research study last fall found that the average student debt balance is $26,682, and that more than 1 in 10 graduates are carrying close to $62,000 in unpaid student loans. Both numbers are up sharply from just five years earlier.

Lenders and realty agents who work with first-time buyers say the student debts that many bring to the table are often deal killers because they can’t qualify under current debt-to-income limits.

The huge debt levels are preventing first-time buyers with very large student loan burdens from qualifying because their back-end ratios are too high. They can’t afford the mortgage. The implication in the above statements is that debt-to-income ratio requirements should be loosened. That’s not the answer. The reason we have the so-called stringent debt-to-income limits is because when borrowers were allowed to borrow more, they defaulted. Only Ponzis can survive at higher debt-to-income ratios for a while because they are running personal Ponzi schemes.

But really, it’s worse than just too much debt. A huge number of student loan borrowers simply aren’t paying back the loans. Those who are delinquent on their student loans don’t have the credit scores to qualify regardless of their debt-to-income ratios.

Rising Student-Loan Delinquencies Hurt Young Homebuyers

By Janet Lorin – Feb 28, 2013 8:00 AM PT

More people borrowing for education are failing to pay off their loans.

Almost a third of student-loan borrowers in repayment were delinquent at the end of last year, up from about a quarter in 2008 and 20 percent in 2004, according to a report on household debt and credit today by the Federal Reserve Bank of New York.

A third? I had no idea the problem was that bad.

The amount of educational debt, which includes federally backed and private loans taken out by students and parents, has almost tripled in the past eight years to $966 billion, the bank said. With costs to attend college continuing to outpace the inflation rate, more borrowers are struggling to pay. That makes it harder for people — especially those between 25 and 30 — to secure other types of credit, including home mortgages. …

The excessive student loan debt explains much of the decline in homebuying. Even those with jobs can’t afford a mortgage payment.

As more people attend college, the average educational loan balance, as well as the numbers of borrowers and delinquencies are increasing. The number of student-loan borrowers was almost 39 million in 2012, up 70 percent from about 23 million in 2004. The average balance in 2012 per borrower was $24,700 compared with $15,308 eight years earlier.

Total student-loan debt in the fourth quarter was $966 billion, up $10 billion from the previous quarter, according to the New York Fed. The federal Consumer Financial Protection Bureau put the number at $1 trillion last year.

Those are astonishing numbers. Lenders inflated a massive student loan bubble because they knew they would get paid back. Either the borrower would pay them or the government would, and with nearly a third not paying, you and I are.

Ryann Roberts, 22, is one of those borrowers and has seen friends struggle with their debt as a large share of monthly expenses.

She is deferring on more than $37,000 in loans for an undergraduate degree in health policy at Carnegie Mellon University in Pittsburgh and for the first year of a two-year master’s in public health at George Washington University. She has kept her graduate costs low by working full-time as an administrator at the university’s medical school, which waives some tuition for employees.

“I’m worried about graduating and making enough money to pay the loan back and stay afloat,” Roberts said.

She should be worried. She has far too much debt compared to the salary of the career in front of her.

Student loan debt is an area where some government paternalism is in order. Government-backed student loans are an investment in human capital that has historically shown a good return to the taxpayer through higher wages and tax revenues. However, if we are going to have government backing, we need government oversight to protect the taxpayer. One of these protections should be a cost-income analysis that limits the debt students can take on to get certain degrees. As it stands now, if we’re in for a penny, we’re in for a pound. Once a borrower starts school, we are obligated to giving them the chance to finish and get the degree so they can repay the debt even if the job at graduation is low paying. We are subsidizing people like the woman above who are taking on huge debt loads for degrees with little income potential. This doesn’t help the borrower or the taxpayer.

Something needs to be done to curb the wild growth in student loan debt. These huge debt loads are increasing becoming a drag on the economy. Recent graduates with such large debt loads aren’t buying houses, cars or consumer goods because so much of their income is going toward student loan debt. Until this situation changes, the first-time homebuyer cohort will be weak, and the ripple effect will dampen sales throughout the housing market for years to come.