Attributed to Yogi Berra, the phrase “déjà vu all over again” has worked itself into our national vernacular. Although the expression is funny on one level, it also describes the current real estate crisis in a way that is less amusing.
As I listen to the national rhetoric around the current real estate market, I am being bombarded with comments, from the president on down, that we need the Fed to lower rates to get the market back on track. The idea is that by lowering the Fed rate, mortgage rates will also come down, and the lower costs to borrow will spur more buyers to enter the market and get things moving.
A couple of thoughts on lowering interest rates
To begin, I must clarify that I am not an accountant, economist or anyone particularly good at slicing and dicing numbers. What I am good at, however, is representing my client’s best interests, and that, in essence, is the heart of this post. The question I am asking is, “What is in the best long-term interest of our clients?”
First, we are forgetting that the primary issue has not been a lack of potential buyers; it has been an absence of inventory to sell to them. As an example, in our market, homes that were purchased 30 or more years ago for a couple of hundred thousand dollars can now sell for well over a million, resulting in a huge capital tax burden that many seller wannabees are refusing to pay.
Consequently, instead of putting their homes on the market and relocating, downsizing and so on, they are hunkering down for the long haul. As a result, in our market, the move-up/move-down segment of the market is virtually nonexistent. And that is only one of the factors many markets are dealing with.
Second, lowering mortgage rates might not actually be a good idea.
Before we go any further, keep in mind that I am addressing what is best for the consumer, not what is best for the real estate industry. If we truly believe that our clients come first, then we need to rethink what that really means.
Looking back on the housing boom between 1997-2006, thanks to low interest rates, easy credit and relaxed lending standards, everyone was out shopping for homes. Factor in adjustable-rate mortgages (ARMs) with almost no prequalification standards, and it is safe to say the market was on fire. This led to competitive bidding, which in turn forced prices up dramatically.
Everything came to a head when the ARM rates readjusted upward, and many (who should never have been allowed to purchase to begin with) could no longer pay their mortgages. A flood of homes hit the market, which in turn pushed prices down.
Suddenly, many homeowners owed more on their properties than the market was willing to pay. The result was a torrent of short sales, which then morphed into foreclosures.
The cause? An overabundance of loans at ridiculously low initial rates
Fast forward to March 2020, when, responding to the pandemic, the Fed began slashing rates. Designed to sustain the housing market, rates became so low that the floodgates were opened to many who previously could not afford to buy, and, with the resulting surge of buyers, the market again caught fire, causing home prices to escalate rapidly.
Additionally, many existing homeowners refinanced their properties at sub-3 percent rates, effectively locking them into their homes for the foreseeable future. Properties that would normally have been available to purchase no longer reached the market, which in turn pushed prices even higher.
The cause? An overabundance of loans at ridiculously low rates
Déjà vu all over again.
Maybe it’s just me, but someone needs to be asking, “Do we really want to go down this road again?” Low interest rates are not the panacea we tend to think they are. Yes, they spur market activity. Yes, real estate agents flourish. Unfortunately, there is a dark side as well.
The downside of lower interest rates
1. Home prices increase
As we have seen in the past, not only do prices rise, but they have also historically outpaced inflation, which in turn creates a housing bubble that prices many buyers out of the market, increasing the affordability gap.
2. Debt ratios rise
If you look at conventional loan requirements between 1945 and 1950, there are a few important things to understand. Wages were relatively low, most households had only one income and consumer credit as we know it today was virtually non-existent.
In this environment, allowable debt-to-income ratios (DTI) were between 20 percent to 25 percent, and downpayments ranged between 20 percent to 50 percent. In spite of this, the housing market flourished because prices were low.
Contrast that with today, where a significant number of potential buyers must rely on family members to come up with acceptable downpayments, dual incomes are required to qualify in many cases, the DTI is much higher, and consumer credit is out of control.
As home prices continue to rise faster than inflation, this problem will worsen, additionally widening the affordability gap. This also has some unforeseen consequences. As an example, some couples, hoping to secure a home, put off having children until a later date.
3. True homeownership costs are hidden
As inflation continues to push prices up, many homeowners have discovered that while their income remains the same, the costs of homeowner’s insurance, maintenance and so on increase past their ability to pay, robbing them of the funds they would normally have spent on vacations or other family-building activities. Some dive into consumer credit to meet the gap, further worsening the issue.
4. Increased speculation
Low rates allow speculators and investors increased ability to snap up local inventory, which in turn forces prices even higher.
The only effective way to really open up the market is for homes to become more affordable, which means lower prices. A second factor that would bring more homes to the market would be for the government to get off its proverbial backside and increase the home sale tax exclusion or completely remove capital gains from home sales.
There are no easy solutions going forward, but I do not believe slashing rates will have the desired effect. In fact, it would most likely make things even worse. Our goal should be to seek solutions that make homeownership more affordable for a much wider percentage of the population.
Berra stated, “We made too many wrong mistakes.” We are already down two strikes. As Berra said, “One more strike and it might be over before it’s over.”