How Are Credit Conditions Hurting the Housing Market?

Source: Thinkstock

Source: Thinkstock

We cannot stress enough about how important the housing market is to the U.S. economy.

According to an article by The New York Times published in April this year, if residential investment returned to its post-world war, long-term average of about 4.8 percent of gross domestic product, then overall GDP growth could jump to 4 percent — a level last seen in the 1990s. Such a growth rate would add 1.5 million jobs to the economy, bringing down the unemployment rate by a full percentage point.

Now picture this: at about 3.1 percent of GDP, investment in residential property in the U.S. remains smaller now than it was at any time since World War II. But five years after a housing-fueled financial crisis, the market seems somewhat content with this as a new normal. Even with the Federal Reserve engaged in aggressive monetary stimulus, residential investment still hasn’t returned to its long-term average. Tighter credit controls, relatively high mortgage rates, and increases in student debt have crowded out loan demand, and sustained increases in home prices are hurting demand.

According to data provided by National Association of Realtors, single-family home sales stood at 4.30 million in May, 5.7 percent below the 4.56 million pace a year ago. The median existing single-family home price is up 4.9 percent on the year to $213,600 in May and the median existing condo price has risen 6.6 percent to $212,300. The share of first-time buyers remains low at 27 percent, down from 29 percent in April last year.

An obvious outcome of the crisis has been that banks are extremely wary of borrowers with poor credit scores. The top 25 lenders accounted for 63.9 percent of all originations in the first quarter this year, the lowest level lowest in 14 years. The share is down down from 90.9 percent in 2008, data published by Inside Mortgage Finance showed.

According to a report published by Federal Reserve Bank of Boston, “Most visibly, [banks] stopped making ‘subprime’ loans to households with especially poor credit histories. Households with credit scores (provided by FICO) below 620 — a score that might be triggered, for example, by being 90 days late on a loan payment — essentially lost any access to mortgage borrowing.” Lenders also disallowed borrowers from ever-greening their mortgage debt by taking out “piggyback” second mortgage to make a down payment. This tightening of credit standards by banks has removed a chunk of borrowers from the housing market place.

Even for those who meet lenders’ criteria, the cost of credit has hardly got any cheaper. The 30 year Freddie Mac Fixed mortgage commitment rate has increased to 4.19 percent in May from 3.54 percent in May 2013.

On the other hand, student debt has been rising like never before, which is pushing prospective young home buyers to delay their decisions to purchase homes. The demand for student loans has continued to grow consistently through the recession to the present day. The number of student borrowers has increased by 70 percent between 2004 and 2012, and the size of borrowing per person has also gone up by 70 percent, Federal Reserve Bank of New York data shows.

But some hope is expressed in the report published by Boston Fed, which says that this gap in supply of credit for the borrowers with poor credit scores from low to medium income households has been met by the Federal Housing Administration. Single-family purchase mortgages guaranteed by the FHA grew from 300,000 in 2006 to 1.1 million in 2010. Correspondingly, the FHA share of single-family purchase originations jumped from 5 percent to 44 percent. The FHA increased the maximum loan size it could guarantee to $730,000 around the same time.

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