Friday, June 22, 2012

Are Home Prices Really All That Low? ... And Even If They Are, So What?

Contrary to what realtors and everybody else, including government officials, may be saying about how low home prices are today, Why Housing Affordability is a Mirage is worth a look:

"Home prices and mortgage rates have made monthly mortgage payments lower than at any time in the past decade. But housing isn’t any more affordable than it was five years ago, during the go-go lending days, after factoring in down payment requirements and other financing terms, according to a new paper.

The National Association of Realtors and other housing economists typically measure housing affordability by looking at home prices and mortgage rates. Prices of course have fallen to nearly 10-year lows nationally, while rates have never been lower. Freddie Mac on Thursday said rates stood at 3.71% this past week for the average 30-year fixed-rate mortgage.

But the total cost of homeownership, as a share of a borrower’s income, is the same today as it was during the height of the housing mania . . . .

The reason: borrowers have to put more money down to get a loan, and the exotic lending products that allowed borrowers to make low initial payments have gone away. That means while the absolute monthly payments are lower, the all-in costs of homeownership haven’t become more favorable.

Today, most lenders require minimum down payments of 20%, though loans with down payments of just 3.5% are still available through the Federal Housing Administration. During the peak of the housing boom, borrowers could bypass pesky down payments by taking out second mortgages or obtaining mortgage insurance.

“Home affordability needs to be considered in light of the full financing package,” said Mr. Davidson. “During the bubble the low all-in cost of mortgage financing allowed borrowers to purchase homes, even at inflated prices.”

The erosion of down-payment requirements from 2000 to 2006 reduced borrower costs by around 15%, according to Messrs. Davidson and Levin, while tighter down-payment standards since 2006 have raised borrower costs by 22%. That more than offsets the benefit of a drop in interest rates from around 6% to less than 4%.

At the peak of the housing bubble, loan payments were the only cost that borrowers had to consider given the ability to take out no-money-down loans. But today, loan payments constitute roughly 50% of the total cost of ownership “and are rather modest by historical standards,” the paper says. “This explains why the record-low interest rates do not impress borrowers and do not propel home prices up.”"

My Take

No Money Down

The "good old days" of no money down home buying are gone. Besides, they weren't really "good old days" at all and contributed heavily to the housing price bubble and its subsequent bursting.

That said, home prices today still aren't all that cheap after factoring in the "opportunity costs" associated with down payments and other all-in costs of home buying.

Opportunity costs simply mean that down payments require an individual to forgo any alternative investment using that same money.

Thus, the down  payment represents the biggest reason why all-in homeownership costs haven't declined even as interest rates have fallen substantially since the bubble days.

Affordability Isn't the Only Thing

My view for why home buying remains low, other than the affordability factor, is that more and more people have come to realize that home prices aren't always on a one-way can't miss sure thing upward escalator.

If that real world fact of the matter is entering the picture, that's a very good thing for individuals and prospective home buyers, even if not such a great thing for the residential real estate industry.

In sum, there's nothing wrong with homeownership, but it's definitely not a panacea either.

When to Buy

If you have the cash readily available to make the required down payment, intend to occupy the house for at least a decade or more, and feel secure about your future income stream, then now isn't a bad time to buy.

That said, it's not such a great time to buy either.

There is no obvious reason why home prices, depending on the area and neighborhood, can't fall further. And there's no obvious reason why interest rates will increase much anytime soon either.


Thus, why hurry?  There's certainly no need to do so.

Both rates and prices aren't going anywhere very far very soon.

Keeping your powder dry is hardly ever a bad idea.

And it's not a bad one now.

Thanks. Bob.

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