Does Current Home Prices Bring Relief To Homebuyers?

There is a terrible house price adjustment in the US. It may sound like déjà vu, but the causes of the recent housing market booms and busts are different from those of the 2000s. 

This time, the American financial system is better prepared and a national crisis is less likely.

American owners need to prepare for 2023. After years of stagnant investment and stagnant supply, US home prices rose 45% between January 2020 and June 2022, fueled by low-interest rates and growing demand for work-from-home jobs. 

By comparison, before the housing crisis that began 16 years ago, prices rose by 30% over a similar period.

But the housing bubble of the 2000s was fueled by predatory lending, poor insurance, variable rate mortgages, and rampant speculation. 

Americans were convinced that housing was a great short-term investment and that prices would continue to rise. Turns out that’s not the case.

As interest rates rose through 2006, prices began to fall later that year and homeowners started to default on their mortgage payments. 

As prices continued to fall, homeowners tried to sell their properties, creating a feedback loop that worked its way through the housing market.

The subsequent financial crisis was caused by massive defaults on subprime mortgages backed by mortgage-backed securities. These assets suddenly became obsolete and threw the financial system into crisis.

In addition, years of high demand led builders to overbuild in the early 2000s, flooding the country with oversupplied homes. 

As a result, it took several years after the Great Recession for demand to work through the massive housing stock. This in turn destroyed the housing industry and led to chronic construction for years to come. The current situation is very different.

Home prices are falling as the Fed raises interest rates to curb inflation. This, in turn, led to rising mortgage rates. 

Average 30-year mortgage rates fell last week, but more than double from a year ago (3.10% a year ago and 6.61% today). These rates make financing a new home too expensive for many buyers, slowing demand and driving down prices.

Fortunately, supply and demand fundamentals may limit the downward trend in US home prices. Millennials, the largest generation after baby boomers, are aging and looking to buy their first homes. 

Unfortunately, there is not enough rotation. However, this means that even if the high price starts to come down, there can and will be some stiffness. Millennial demand could help prevent prices from crashing as they did in 2008. This fall is unlikely to trigger another financial crisis.

In addition, new regulations were introduced in the years following the 2008 financial crisis. Banks now need better capitalization. 

Higher-quality loans with stricter credit standards are possible. Most mortgages have a fixed interest rate. Financial derivatives, such as asset-backed securities, are better regulated. 

All of this props up the financial system for another downturn in the housing market.

Another beneficial trend is the increase in refinancing activity due to extremely low-interest rates in recent years. 

This can lower monthly payments for many homeowners and make it easier to service a mortgage. Americans also held significant housing wealth before the recent financial crisis.

The loan-to-value ratio, which measures a mortgage’s value to a home’s value, fell to a 12-year low of 42 percent for U.S. mortgages. 

This creates more of a “cushion” for falling prices before the home’s value drops below the loan payments. So if a house sells at a loss, it could hit the owner before it gets to the bank.

The current correction in housing prices will hurt the US economy, but lower housing prices will help contain high inflation. 

In practice, this will come at the expense of economic growth, as real estate activity will soon slow and consumer confidence (and spending) could suffer. However, we are unlikely to repeat 2008.