Real estate investors have done very well in recent years. But with higher interest rates, things could be about to change.
The US Federal Reserve raised its benchmark interest rates by 0.75 basis points on Wednesday, marking the third consecutive increase of its kind.
Higher interest rates translate to higher mortgage payments – not good news for the housing market. But cooling 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 supply and demand to better align so that housing prices go up at a reasonable level, at a reasonable pace, and people can buy homes again,” said the Fed chairman, Jerome Powell on Wednesday. “Probably, in the real estate market, we have to go through a correction to get back to that place.”
“From a business cycle perspective, this difficult correction should put the housing market back in better balance.”
Those words might sound scary, especially for those who lived through the last financial crisis – where the housing market went through a very, very difficult correction.
But experts say there’s good reason to believe that, however things turn out, it won’t be a return to 2008.
Higher borrowing standards
Questionable lending practices in the financial sector were a major factor that led to the housing crisis in 2008. Financial deregulation made it easier and more profitable to make risky loans – even to those who could not pay.
So when an increasing number of borrowers were unable to repay their loans, the housing market plummeted.
That’s why the Dodd-Frank Act was enacted in 2010. The law imposed restrictions on the financial sector, including creating programs to prevent mortgage companies and lenders from making risky loans.
Recent data suggests that lenders are indeed stricter in their lending practices.
According to the Federal Reserve Bank of New York, the average credit score for newly created mortgages was 773 in the second quarter of 2022. Meanwhile, 65% of newly created mortgage debt was to borrowers with credit scores above 760.
In its Quarterly Report on Household Debt and Credit, the New York Fed stated that “credit scores on newly created mortgages remain quite high and reflect stringent and ongoing lending criteria.”
Owners in good shape
When house prices rose, homeowners built more equity.
According to mortgage data and technology provider Black Knight, mortgage holders now have access to an additional $2.8 trillion in equity in their homes compared to a year ago. This represents a 34% increase and more than $207,000 in additional capital that is available to each borrower.
Furthermore, most homeowners have not defaulted on their loans, even at the height of the COVID-19 pandemic, where lockdowns sent shockwaves through the entire economy.
Of course, it was these mortgage deferral programs that saved struggling 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 past dues remained at 0.5% at the end of the second quarter, close to an historic low.
Supply and demand
On a recent episode of The Ramsey Show, host Dave Ramsey pointed out that the big problem in 2008 was a “huge oversupply because foreclosures went everywhere and the market just froze.”
And the crash was not caused by interest rates or the health of the economy, but by “a real estate panic”.
At the moment, demand for housing remains strong while supply is still in short supply. That dynamic could begin to change as the Fed tries to contain demand by raising interest rates.
Ramsey acknowledges the slowdown in the rate of increase in house prices at the moment, but does not expect a crisis like the one in 2008.
“It’s not always as simple as supply and demand – but it almost always is,” he says.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.