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Tuesday, May 5, 2009

Mortgage Lending and the Search for the Bottom

Housing statistics are like a good news - bad news thing now. The good news is that there are more sales taking place in markets that have been hammered like Phoenix. The bad news is that prices are falling and don't seem to want to stop. What does this mean for the housing market and real estate lending?

The obvious conclusion is that the number of sales is increasing because the prices are coming down to a reasonable level. We are actually seeing multiple bids taking place for homes at the lower end of the market. First time home buyers can finally afford to buy a home which is a wonderful silver lining that doesn't get much attention in the media. Real estate investors are also able to buy some of these low end homes, often at trustee sales or from banks. These investors make repairs and rent the homes for a profit.

These two players in the market (first time home buyers & real estate investors) are able to win because of the funding available to them. For first time home buyers, they are primarily utilizing FHA loans with a low down payment (3.5%) to secure their financing. Government guaranteed loans are about all that is left and first time home buyers are often the biggest users of these loans.

Real estate investors don't have many financing options available. With excellent credit, income they can document, and a significant down payment, they can secure a Fannie Mae or Freddie Mac loan. More often than not, they pay cash or get a private money loan with an even larger down payment (40% or more) and high interest rate. But because the sales prices are so low (I have seen many sales between $20,000 and $50,000) they have enough cash to purchase the property without financing or put down such a large down payment that their debt service is low enough to generate positive cash flow.

What about everyone else? The player that is absent from this market is the move-up buyer. There are a couple of factors keeping this player from participating. First, they already have a house that they are unable to sell. In the past, move-up buyers could sell their existing home for a profit and use that profit as the down payment for a newer, nicer home. That's not the case today. In fact, if they bought their home after 2003, it is likely that they owe more on their mortgage than what the home is worth today. Even if a move-up buyer can overcome their first challenge, their second challenge is the lack of jumbo mortgages available (loans over $417,000).

Outside of the activity in the lower end homes with first time home buyers and investors, the rest of the market continues to be sluggish. Where is the bottom? If you were looking for an answer to that question in this article, you will be disappointed. I don't know. However, homes are finally priced at affordable levels. So it is reasonable to infer that prices may stabilize soon. The wild card is employment and income. If unemployment continues to be an issue, and it likely will, and incomes continue to decline, and they likely will, then housing still has further to fall. Once it does stabilize it will be a very long time before they rise again.

Unfortunately this is what banks and lenders are thinking when they analyze their lending guidelines. They are afraid to give loans secured by a declining asset. So they don't lend, and people can't buy, and the negative loop continues.

I'll try and finish on something more positive next time.