The real reason MLS inventory is so low

Many housing analysts suggest the lack of inventory is because potential sellers are concerned they can’t find another home to buy. This is a red herring. The real reason is the lack of move-up equity.

Back in 2012, I postulated that homeowners would list their homes as soon as prices reached near-peak levels when they could get out without completing a short sale. After watching prices inflate to peak levels and the listings failed to materialize, I concluded that the lack of equity to complete a move-up is what kept supply from coming to market.

Loan modifications kept homes off the market to facilitate the recovery. As these loan modifications expired, some of these properties came to market as equity sales, but if the homeowner’s financial situation improved enough for them to endure the payments, many opted to stay where they are until they had enough equity to buy a nicer property.

Conversation with a loanowner

In 2013, I spoke with a homeowner who couldn’t afford the house he owned held title to (with no equity, he really didn’t own anything). We talked about his situation and options, and here is what he told me:

First, like most homeowners, he and his family were emotionally attached to their property. They wanted to stay because it was a nice home they decorated and customized to their tastes. you can get more info about how to customize your home to your liking.

One of the reasons many loanowners didn’t want to sell is because they would have endured the unceremonious fall from entitlement. People who couldn’t afford their homes were living beyond their means. If they sold and found a rental, they would be forced to live within their means in a property they can afford. For most loanowners, that means taking a step down the property ladder, and nobody wanted to do that.

So unless they were forced to, people wouldn’t voluntarily sell a nice house to move into one they considered substandard. When combined with the emotional attachments of home ownership, most people chose to struggle and fight rather than capitulate and sell.

Another reason this loanowner didn’t plan to sell his house was because he couldn’t buy another one. His credit was trashed because, in order to get his loan modification, he stopped making regular payments, and the missed payments ruined his credit score. If you extrapolate that circumstance to the millions of borrowers who applied for a loan modification, and you begin to understand why owner-occupant loan applications were so low for so long.

This from a 2013 Calculated Risk post:

MBA National Delinquency Survey Loan Count
Q2 2007 Q1 2013 Change Q1 2013 Seriously Delinquent
Prime 33,916,830 28,008,431 -5,908,399 1,134,341
Subprime 6,204,535 4,169,970 -2,034,565 849,006
FHA 3,030,214 7,194,524 4,164,310 574,842
VA 1,096,450 1,645,556 549,106 68,291
Survey Total 44,248,029 41,018,481 -3,229,548 2,626,480

There were 2,626,480 seriously delinquent borrowers who have suffered a lowering of their FICO score. Plus, there were many more in prior years. Keep in mind, these were not ordinary credit problems that typically keep potential homebuyers out of the market. This issue was directly caused by the housing bust, and each of these delinquent borrowers had poor credit and was unable to qualify for a home loan. A big reason these listings didn’t come to market is because these sellers wouldn’t have been able to buy again.

Second, this loanowner wasn’t being compelled to sell due to the cost. With his loan modification, his monthly cost of ownership was lower than a comparable rental. With his 2% temporary teaser rate, his payment was very low. As long as his monthly costs were lower than a comparable rental, it didn’t make sense for him to sell and rent.

When I asked him what happens when his interest rate rose back up to the contract rate, he said one of two things would happen. Either he would be offered another loan modification, or he would be able to refinance into a low-interest rate mortgage. I didn’t press him on the how realistic that was.

Realistically, he wouldn’t be offered another loan modification unless the property were still severely underwater. The serial refinancing of one teaser rate to another died with the collapse of the housing bubble. Banks were willing to modify his loan because the property had no collateral backing, but the loan modification entitlement was rescinded as prices hit the peak.

When a homeowner has equity again, even a tiny amount of it, and the terms of the loan modification increases the borrower’s costs, the borrower may ask for another loan modification, but it’s unlikely they would receive one. Why would the bank cut them a deal once they bank can get paid in full from a sale? It would be better for the bank to force the old owners out in favor of a new one who will pay the full current rate on a home loan.

This loanowner also thought he could get a low-rate mortgage. Given his bad credit, it’s unlikely he would have been given any mortgage, much less a low-rate one.

Basically, he was in denial. He lived on borrowed time, rented from the bank, and reacted to temporary circumstances, hoping something would work out. His incentive was not to sell, so he didn’t. It’s the millions of people like him that aren’t listing their homes for sale today.


Low MLS inventory is the new normal.