Real estate investors have done fairly well over the past few years. But with interest rates rising, things may be about to change.
The US Federal Reserve raised benchmark interest rates by 0.75 basis points on Wednesday, the third such increase in a row.
Higher interest rates translate to larger mortgage payments – not good news for the housing market. But lowering home prices is part of what needs to be done to control inflation.
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“In the long term, what we need is for supply and demand to be better aligned, so that home prices rise at a reasonable level, at a reasonable pace, and people can buy homes again,” Fed Chair Jerome Powell said on Wednesday. “Maybe we in the housing market will have to go through a correction to get back to that place.”
“From a business cycle point of view, this difficult correction should return the housing market to a better equilibrium.”
Those words may sound frightening, especially to those who have experienced the recent financial crisis – the housing market has gone through a very difficult correction.
But experts say there are good reasons to believe that no matter how things go, it will not be a return to 2008.
Higher Lending Standards
Questionable lending practices in the financial industry were a major factor that led to the housing crisis in 2008. The liberalization of financial regulation made it easier and more profitable to offer risky loans – even to those who could not afford them.
So when an increasing number of borrowers could not repay their loans, the housing market erupted.
That’s why the Dodd-Frank Act was enacted in 2010. The law placed restrictions on the financial industry, including creating programs to prevent mortgage companies and lenders from making shady loans.
Recent data indicates that lenders are already much stricter in their lending practices.
According to the Federal Reserve Bank of New York, the average credit score for newly emerging mortgages was 773 for the second quarter of 2022. Meanwhile, 65% of newly emerging mortgage debt was to borrowers with credit scores above 760.
In its quarterly report on household debt and credit, the Federal Reserve Bank of New York stated that “credit scores on new-origin mortgages remain very high and reflect continued stringent lending standards.”
Homeowners in good condition
When home prices rose, homeowners built more equity.
According to mortgage tech and data provider, Black Knight, mortgage holders can now access an additional $2.8 trillion in equity in their homes compared to last year. This represents a 34% increase and more than $207,000 in additional capital available to each borrower.
Moreover, most homeowners did not default on their loans even at the height of the COVID-19 pandemic, as the shutdowns sent shockwaves throughout the economy.
Of course, it was these mortgage bearing programs that saved distressed borrowers: they were able to pause their payments until they regained financial stability.
The result looks great: The New York Fed said the share of 90-day mortgage balances plus overdue remained at 0.5% at the end of the second quarter, close to a historical way.
Supply and demand
On a recent episode of The Ramsey Show, host Dave Ramsey noted that the big problem in 2008 was “a massive oversupply because foreclosures went everywhere and the market just froze.”
The collapse was not due to interest rates or the health of the economy but rather to a “real estate panic”.
At the moment, the demand for housing remains strong while the supply is still in short supply. This dynamic could start to change as the Fed tries to curb demand by raising interest rates.
Ramsay acknowledges the slowdown in the rate of home price increase right now, but he doesn’t anticipate a crisis like 2008.
“It’s not always as simple as supply and demand – but it always is,” he says.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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