Real estate investors have largely done 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 such rate hike in a row.
Higher interest rates translate to higher mortgage payments, which is not good news for the housing market. But cooling house prices is part of what needs to be done to control inflation.
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“In the longer term, what we need is for supply and demand to be better aligned, for house prices to rise to a reasonable level, at a reasonable pace, and for people to be able to buy a home again.” Fed Chairman Jerome Powell said on Wednesday. “Probably in the housing market we will have to go through a correction to get back to that place.”
“From a business cycle kind of standpoint, this difficult correction should bring the housing market back into better balance.”
Those words may sound scary, especially to those who lived through the last financial crisis, where the real estate market went through a very, very difficult correction.
But experts say there’s good reason to believe that however things play out, it won’t be a throwback to 2008.
Higher lending standards
Questionable lending practices within the financial industry were a major factor leading to the housing crisis in 2008. Financial deregulation made it easier and more profitable to make risky loans, even to those who couldn’t afford them.
So when an increasing number of borrowers were unable to repay their loans, the housing market collapsed.
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 risky loans.
Recent data suggests that lenders are, in fact, tightening their lending practices.
According to the Federal Reserve Bank of New York, the median credit score for newly originated mortgages was 773 for the second quarter of 2022. Meanwhile, 65% of newly originated mortgage debt went to borrowers with credit scores above 760.
In its quarterly Household Credit and Debt Report, the New York Federal Reserve stated that “credit ratings on newly originated mortgages remain fairly high and reflect continued stringent credit criteria.”
Owners in good shape
When home prices rose, homeowners accumulated more capital.
According to mortgage technology and data provider Black Knight, mortgage holders now have access to an additional $2.8 trillion in equity in their homes compared to a year ago. That represents a 34% increase and more than $207,000 in additional capital available to each borrower.
Furthermore, most homeowners did not default on their loans even at the height of the COVID-19 pandemic, where lockdowns sent shock waves throughout the economy.
Of course, it was those mortgage forbearance programs that saved struggling borrowers: They were able to pause their payments until they regained financial stability.
The result looks very good: The New York Federal Reserve said the proportion of mortgage balances more than 90 days past due stood at 0.5% at the end of the second quarter, close to a record level.
Offer and demand
On a recent episode of The Ramsey Show, host Dave Ramsey noted that the big problem in 2008 was a “tremendous oversupply because foreclosures spread everywhere and the market just froze.”
And the crash was not caused by interest rates or the health of the economy, but by “a housing panic.”
Right now, housing demand remains strong, while supply remains tight. That dynamic could start to change as the Fed tries to rein in demand by raising interest rates.
Ramsey acknowledges the slowdown in the rate of increase in home prices at the moment, but he 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.