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 consecutive such hike.
Higher interest rates mean bigger mortgage payments, which is not good news for the housing market. But cooling house prices is part of what needs to be done to bring inflation under control.
“Longer term, what we need is for supply and demand to be better aligned, so that house prices rise at a reasonable level, at a reasonable pace, and people can once again buy houses,” Fed Chairman Jerome Powell said Wednesday. “We in the housing market probably have to go through a correction to get back to this place.”
“From a bit of a business cycle perspective, this tough correction should bring the housing market back into balance.”
Those words might sound scary, especially to those who lived through the last financial crisis – where the housing market went through a very, very tough correction.
But experts say there’s good reason to believe that, however things go, it won’t be a 2008 comeback.
Higher lending standards
Questionable lending practices within the financial sector were a major factor that led to the housing crisis in 2008. Financial deregulation has made it easier and more profitable to provide risky loans, even to those who do not couldn’t afford it.
So when an increasing number of borrowers failed to repay their loans, the housing market collapsed.
That’s why the Dodd-Frank Act was signed into law in 2010. The act 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 indeed stricter in their lending practices.
According to the Federal Reserve Bank of New York, the median credit score of newly issued mortgages was 773 for the second quarter of 2022. Meanwhile, 65% of newly issued mortgage debt was to borrowers with higher credit scores. at 760.
In its quarterly report on household debt and credit, the New York Fed said that “credit ratings for new mortgages remain quite high and reflect still stringent lending standards.”
When house prices rose, homeowners accumulated 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. This represents a 34% increase and over $207,000 in additional equity available to each borrower.
What’s more, most homeowners haven’t defaulted on their loans, even at the height of the COVID-19 pandemic, where lockdowns sent shockwaves through the economy.
Of course, it was these mortgage forbearance programs that saved struggling borrowers: they were able to suspend payments until they regained financial stability.
The result looks great: the New York Fed said the share of mortgage balances 90 days and older in arrears remained at 0.5% at the end of the second quarter, near an all-time high.
Supply and demand
On a recent episode of The Ramsey Show, host Dave Ramsey pointed out that the big problem in 2008 was “huge oversupply because foreclosures went all over the place and the market just froze”.
And the crash was not caused by interest rates or the health of the economy, but rather by “a real estate panic”.
At present, the demand for housing remains strong while the supply is still insufficient. This dynamic could start to change as the Fed attempts to dampen demand by raising interest rates.
Ramsey acknowledges the slowdown in the rate of house price increases right now, but doesn’t expect a slump 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.