Apr172017
Large down payments stabilize the housing market
Large down payments shut many borrowers out of the housing market — many unreliable ones — which is why large down payments make housing so stable. It’s also why many rally against it.
Down payments form the bedrock of the housing market. Large down payments serve the interests of homeowners and politicians by
- preserving homeownership,
- lowering volatility in the market, and
- reducing the risk to our financial system.
The primary people who oppose large down payments profit from short-term boosts in transaction volumes and higher prices, realtors and originate-to-sell lenders. Left-wing housing advocates also view large down payments as a barrier to putting unqualified borrowers into houses — of course, they fail to acknowledge the “unqualified” nature of many of these borrowers.
Down payments preserve home ownership because people who invest large down payments rarely default. In purely economics terms, people shouldn’t consider sunk costs like down payments in their decision making. However, homeowners do.
People simply don’t walk away from properties where they invested a great deal of their own money, even if they’re deeply underwater and that money is only a memory. The decision is more emotional than logical. But when coupled with the emotional desire to “own,” these two forces dissuade most people from strategic default even when that option is the best available to them.
Down payments clearly have a strong impact on delinquency that can’t be ignored. Delinquency rates on high down payment loans are a small fraction of what delinquency rates are on low down payment loans.
Down payment reduce market volatility in two ways. First, as mentioned previously, large down payments reduce strategic default. Fewer foreclosures in a time of financial crisis means less pressure on house prices. Plus, large down payments serve to limit the inflation of prices during a rally. Large down payments reduces the size of the buyer pool (which is why lenders and realtors want down payments reduced or eliminated). A thinner buyer pool puts less upward pressure on prices. It takes people time to save for larger down payments, and this serves to limit price increases by the rate of savings of potential buyers.
Ultimately, down payments limit the risk to our financial system because they reduce the volatility in the housing market. Our financial system nearly crashed in 2008, which was triggered by the collapse of the housing bubble.The destabilizing impact of low down payments is far reaching. That’s why it’s particularly dangerous that a small group of self-interested parties is lobbying to reduce or eliminate down payment requirements from the new qualified residential mortgage standards.
The downside of large down payments
Over the last 10 years, and even now, politicians and bankers obsess over increasing lending to stimulate the economy. Large down payments limit lending because it prevents people without the fiscal discipline to save and consistently make payments from obtaining loans.
However, this type of myopic thinking ignores the basic reason down payments are so important: Down payment requirements weed out the people lenders should least want to loan money to. (See chart above).
And who said home ownership is an entitlement that lower-income borrowers should have? Lower income borrowers who can save 3.5% can buy a property that their income can support. The FHA down payment hurdle is hardly onerous.
Dodd-Frank whiffed on down payments
While the new mortgage regulations will prevent future housing bubbles, these regulations leave out the lynchpin of the whole system, down payments. For decades, experts emphasized the need for a sizable down payment — a rule of thumb being 20 percent — on the premise that borrowers with a sizable chunk of equity in a home are less likely to walk away when things get bad.
“If our goal is to prevent foreclosures, I can’t think of anything more effective than requiring a down payment,” said Paul S. Willen, a senior economist and policy adviser at the Federal Reserve Bank of Boston.
As I noted, large down payments prevent many from submerging beneath their debts, leading to a reduction in strategic default. Fewer defaults mean fewer foreclosures. However, it isn’t just the number of foreclosures that’s the problem. The losses lenders must absorb if they do foreclose is what imperils our banking and financial system.
If the bubble-era borrowers all put 20% down in their respective banks (swift code transfers), banks wouldn’t have lost so much money during the bust. In fact, if you pay careful attention to what the Chinese say about their own housing bubble, they insist it isn’t a problem precisely because their down payment requirements are so high.
There is no reasonable argument to be made in favor of small down payments. The only people trying to obfuscate the issue are left-wing housing advocates, realtors, and originate-to-sell lenders who have their own self-serving agendas. The reality is that large down payments provide stability to housing markets and our financial system.
Leaving coastal California is a ‘no-brainer’ for some as housing costs rise
Huntington Beach residents Chris Birtwistle and Allison Naitmazi were about to get married and decided it was time to buy a home.
They wanted to stay in the area but couldn’t find a house they both liked and could reasonably afford — despite a dual income of around $150,000.
So they decided to go inland — all the way to Arizona, where they recently opened escrow on a $240,000, four-bedroom house with a pool just outside Phoenix. Their monthly mortgage payment will be about $500 less than what they paid for a two-bedroom apartment in the Orange County beach community.
“The only hesitation was [leaving] the great weather,” the 31-year old Birtwistle said. “But we talked about what we can get here and what we can get there for the same price and that was a no-brainer.”
To escape high prices, people — often younger and with lower- or middle-class incomes — are looking toward the Inland Empire and nearby states for additional square footage and a lower mortgage payment.
“[Migration] is settling back into longer-term patterns,” said Jed Kolko, chief economist with employment website Indeed.com who analyzed the data.
Others were more blunt.
“The impact is to create an auction situation between the haves and the have-nots,” Christopher Thornberg, founding partner of Beacon Economics, said of the housing shortage. “And the have-nots have to move away.”
This will go nowhere.
Republicans propose drastic overhaul of Dodd-Frank and CFPB
The updates to the leading Republican effort to replace the Dodd-Frank Wall Street Reform and Consumer Protection Act are out, which include possible changes to the leadership structure of the top housing agencies.
A memo first came out on potential plans reportedly from House Financial Services Committee Chairman Rep. Jeb Hensarling, R-Texas, back in February, revealing an even more aggressive version of the Financial CHOICE Act.
That memo showed that the Consumer Financial Protection Bureau was facing some of the most dramatic changes under the updated Act.
Previously, the CHOICE Act 1.0 proposed leadership changes for not only the CFPB, but the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and the National Credit Union Administration as well.
But looking over the new summary (found here) of the CHOICE Act 2.0, the language walks back a lot of the initial CHOICE Act 1.0 proposals.
According to the summary of bill changes, the original CHOICE Act would restructure the FHFA and OCC as bipartisan commissions. The FDIC would be reorganized as a bipartisan commission with all five commissioners appointed by the president, and both the Comptroller of the Currency and the CFPB director would be removed from the FDIC board. Also, NCUA board of directors would be increased from three members to five.
The new CHOICE Act 2.0 cuts a lot of those proposed changes, and instead, the FHFA director would be removable at will by the president, with no changes to the current law regarding OCC and NCUA. The FDIC structure would stay the same as proposed in CHOICE 1.0.
One of the most noteworthy changes in the CHOICE Act 2.0 is its stance on the CFPB leadership structure.
The original CHOICE Act replaced the director of the CFPB with a Consumer Financial Opportunity Commission, a bipartisan independent Commission serving staggered terms.
Instead, in the newest version, the Consumer Financial Protection Bureau would be changed to the Consumer Financial Opportunity Agency, an executive agency with a sole director removable at will. The deputy director would also be appointed and removed by the president.
The Fed raised interest rates. Why are mortgages getting cheaper?
Looks like the homebuying frenzy isn’t going anywhere, at least for now.
After the Federal Reserve raised its key interest rate nearly a month ago, many people expected mortgages rates to creep up. But instead, they’ve been on the decline ever since.
The average rate of a 30-year fixed mortgage fell to 4.08% this week, the fourth consecutive week of declines, and the lowest level this year, Freddie Mac reported Thursday morning.
A higher Federal Funds rate makes it more expensive for banks to borrow money, which can translate into higher borrowing rates for consumers.
But home mortgage rates tend to move more in line with the 10-year Treasury note, issued by the U.S. government and viewed as one of the safest investments in the world. They are widely traded, and lately investors have been gobbling them up. More demand sends the interest rate, or the yield, lower.
“We’ve seen a reversal of the ‘Trump Trade’ which began on election night that consisted of a broad rise in stock prices and bond yields moving up,” explained Mark Hamrick, senior economic analyst at Bankrate.
Los Angeles struggles to retain workers due to high housing costs
Los Angeles may have year-round sunshine and great beaches, but according to an article in the Los Angeles Times by Tracey Lien, it’s not enough to entice workers to accept jobs there.
The article referenced the results of a new survey by the University of Southern California that found the region’s affordability crisis is deterring workers from putting down roots.
From the piece:
“Though we have yet to see a critical mass of businesses priced out of the region, this is an area of concern,” Raphael Bostic, a professor of public policy at USC who led the research, said in a statement.
According to Bostic, high housing costs are leading to employers’ having to develop special hiring packages, subsidize employee transportation or offer relocation costs, which puts a strain on companies’ bottom lines and makes it harder to compete with markets where housing costs aren’t as high.
The affordability problems aren’t unique to only Los Angeles though, as the whole state faces ever-rising home prices. The latest report from PropertyRadar stated that San Francisco Bay Area home sales in February plummeted to the lowest of any month since February 2008 as average home prices soared into the millions.
In order to fix the problem, Madeline Schnapp, director of economic research for PropertyRadar, said, “Local, state and federal housing regulations have made it all but impossible for builders to meet housing demand in California’s growing economy.”
“Conceptually, the solutions to California’s affordability crisis are simple, but politically we should expect the current situation to continue for the foreseeable future,” said Schnapp.
Redfin: U.S. home prices, sales show strong gains as housing shortage continues
Redfin reports that U.S. home prices rose 7.5% to a median sale price of $273,000 in March as home sales made a strong showing, gaining 8.9% over last year. However, the number of homes for sale declined 13% compared to March 2016, marking the 18th consecutive month of declines in supply.
The report indicated that 2017 remains on track to be the fastest housing market on record and the typical home that sold last month went under contract in 49 days, shaving 11 days from last year’s median time on market of 60 days. Nearly one in five, or 19.1%, homes that sold in March went under contract within two weeks and 21.7% of homes sold for more than their list price.
According to the report, 32 out of 90 metropolitan areas saw sales increase by double digits from last year. Poughkeepsie, New York, led in year-over-year sales growth, seeing a gain of 41%, followed by Baltimore, Maryland, which had an increase of 40.6% growth. Camden, New Jersey, rounded out the top three metro areas with a sales increase of 31.6%.
Four East coast cities saw inventory decline more than 30%. Rochester, New York, saw the largest inventory decline, dropping 39% since March last year. Buffalo, New York, saw a 34.5% decline, Rochester, New Hampshire, dropped 33.2%, and Portsmouth, New Hampshire dipped 31.4%. However, these areas also had fewer homes available on the market than last year.
A handful of cities did see modest inventory growth. Fort Myers, Florida, saw the highest increase in the number of homes for sale, up 32.4% from last year, followed by Knoxville, Tennessee, with 22.3% growth and Austin, Texas, which saw 10.3% growth.
“In addition to the laws of supply and demand, today’s open and immediate access to home listing information is really driving the velocity of home sales,” said Alec Traub, a Redfin Los Angeles agent. “In the past, buyers had to wait for their agent to tell them which homes were for sale. Now, when I meet a client for the first time, they already have a home in mind and I can jump in to guide them on what it will take to win it.”
And welcome to the pin that will prick the current bubble. The last bubble was inflated by low loan requirements allowing those who should not buy a house the ability to do so. That included 80/20 loans and ARMs that allowed super low (if any) down payments. Now, it is the FHA loan allowing the same low payments. As stated, the Dodd-Frank Achilles’ heel is allowing those who really cannot afford the ability to buy. Low interest rates contribute by creating a payment that fools the fool into thinking that they can afford it. But what happens when the economy experiences a downturn? What happens if interest rates rise? The same thing that happened before… the fantasy of “I can afford it” becomes the reality of “I overspent”. 20% down shows financial responsibility that MAY allow a buyer to ride out a storm. The last downturn showed that the vast majority of So Cal buyers are one missed paycheck away from disaster. A race to build equity and keep these pseudo-owners in place will fail miserably. Why? Because no matter how much equity they have, they truly cannot afford it unless the economic conditions remain at status quo. Housing prices go down? Bye bye. Inflation taking up more of your paycheck? So long. Interest rates go higher and prevent you from refinancing? Ooops. Employer decides that you don’t get a raise this year? Ouch. All of those impact each home owner, but devastate the one that barely got in the door. And with no equity built up due to a low down payment and being in the initial years of the loan… end of game. You’ve been there over seven years and might be able to escape? Not really. You couldn’t afford to maintain/upgrade your house, so fat chance that you are getting top dollar. None of these buyers were smart enough to avoid getting caught in the more obvious trap during the last housing bubble. This less acknowledged one will slaughter everyone that came to the party with barely enough money to pay the cover charge.
Well said. An equity cushion is critical to surviving any downturn, but when times are good, nobody considers the possibility that times won’t always be so good.
One hidden time bomb waiting to blow up is the end of the grandfather period for GSE and FHA loans that exempts them from Dodd-Frank. Right now, FHA can underwrite loans with back-end debt ratios that exceed 43% due to this exemption. It’s scheduled to expire this year, but I expect another round of can-kicking this problem to another day.