Real estate investors have done a lot 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 hike in a row.
Higher interest rates mean bigger mortgage payments — not good news for the housing market. But cooling housing prices is part of what needs to be done to bring inflation under control.
“In the long term we need to better align supply and demand, so that housing prices rise at a reasonable level, at a reasonable pace, and people can afford homes again,” Fed Chairman Jerome Powell said on Wednesday. “We probably have to go through a correction in the housing market to get back to that place.”
“From a business cycle perspective, this difficult correction should better balance the housing market.”
Those words may sound scary, especially to those who lived through the last financial crisis — when the housing market went through a very difficult correction.
But experts say there are good reasons to believe that no matter how things play out, it won’t be a return to 2008.
Higher lending standards
A major cause of the 2008 housing crisis was questionable lending practices within the financial industry. Financial deregulation made it easier and more profitable to take out risky loans — even to those who could not afford them.
Therefore, 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 Act placed restrictions on the financial industry, including creating programs to stop mortgage companies and lenders from giving out bad loans.
Recent data suggests that lenders are indeed stricter in their lending practices.
According to the Federal Reserve Bank of New York, the median credit score for mortgage originators was 773 for the second quarter of 2022. Meanwhile, borrowers with credit scores above 760 held 65% of origination mortgage debt.
In its Quarterly Report on Household Debt and Credit, the New York Fed said that “credit scores on mortgage originations remain quite high and reflect strict lending criteria.”
Homeowners in good quality
When home prices went up, homeowners built more equity.
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 over $207,000 in additional equity available to all borrowers.
Additionally, most homeowners did not default on their loans even at the height of the COVID-19 pandemic, where foreclosures 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 great: the New York FED said that the share of mortgage balances 90 days plus due in the past remained at 0.5% at the end of Q2, close to how historical.
Supply and demand
On a recent episode of The Ramsey Show, host Dave Ramsey pointed out that the big problem in 2008 was “massive 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”.
Currently, demand for housing remains strong and supply remains tight. That dynamic could start to change as the Fed tries to curb demand by raising interest rates.
Ramsey acknowledges the current slow rate of house price growth but is not expecting a 2008-like crisis.
“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.