Real estate investors have largely done well in recent years. But with higher interest rates, things could change.
The US Federal Reserve raised its benchmark rate by 0.75 basis points on Wednesday, marking the third such increase in a row.
Higher interest rates translate into higher mortgage payments – not good news for the housing market. But house price cooling is part of what needs to be done to bring inflation under control.
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“Longer term, we need supply and demand to better match up so that house prices rise at a reasonable level, at a reasonable pace, and people can afford to buy again,” said Fed Chair Jerome Powell. Wednesday. “We will probably have to make a correction in the housing market to get back to that spot.”
“From a sort of cyclical point of view, this difficult correction should bring the housing market back into balance.”
Those words may sound scary, especially to those who lived through the latest financial crisis — where the housing market went through a very, very difficult correction.
But experts say there are good reasons to believe that no matter how things turn out, it won’t be a return to 2008.
Higher lending standards
Questionable lending practices in the financial sector were a major factor leading to the 2008 housing crisis. Financial deregulation made it easier and more profitable to provide risky loans, even to those who could not afford them.
So when an increasing number of borrowers failed to repay their loans, the housing market collapsed.
That is why the Dodd-Frank Act was passed in 2010. The law imposed restrictions on the financial sector, including creating programs to prevent mortgage companies and lenders from making 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 newly issued mortgages was 773 for the second quarter of 2022. Meanwhile, 65% of newly issued mortgage debt was to borrowers with a credit score above 760.
In its quarterly report on household debt and credit, the New York Fed stated that “credit scores on new mortgages remain quite high and reflect continued tight credit criteria.”
Homeowners in good shape
When house prices rose, homeowners built up 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 more than $207,000 in additional equity available to each borrower.
Moreover, most homeowners did not default on their loans, even at the height of the COVID-19 pandemic, where lockdowns sent shockwaves through the economy.
Of course, it was those mortgage waiver programs that saved the struggling borrowers: They were able to pause their payments until they regained financial stability.
The result looks good: The New York Fed said the 90-day mortgage balance plus delinquency ratio remained at 0.5% at the end of the second quarter, close to 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 “massive oversupply because executions were happening everywhere and the market just froze.”
And the crash was not caused by interest rates or the health of the economy, but rather “a real estate panic.”
At the moment, demand for housing remains strong while supply is still tight. That dynamic could change if the Fed tries to curb demand by raising interest rates.
Ramsey acknowledges the slowing pace of house price growth at the moment, but doesn’t expect a crisis like 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 comes without any kind of warranty.