Will Easing Credit Conditions Offset Weaker Affordability?
BY: BRENDAN K. LOWNEY
It is hard to deny that the sharp deterioration of home affordability which started about a year ago has suppressed home sales and construction. Home prices have been rising steadily for two years and on a national basis are 23% higher than their January 2012 level (according to the Case-Shiller Top 20 metro index). Meanwhile, over the same period, home prices are up even more in the areas that were hit hardest by the implosion of the housing bubble—such as Las Vegas and Phoenix.
Rising mortgage rates dealt yet another whammy to potential home buyers as the rate on the 30-year conventional fixed rate mortgage rose from 3.5% in May 2013 to 4.5% in September and have trended sideways (to slightly down since). The combination of these factors triggered the steepest 6-month decline in home affordability in over 30 years. With such a steep slide in affordability, it’s a small wonder that home sales and starts have lost momentum.
Many analysts underestimated the impact that the deterioration in affordability would have on home sales because affordability remains favorable from a historical perspective. Even under a fairly pessimistic scenario where mortgage rates rise to 5% and home prices increase by another 5% by the end of 2014, the home affordability index would still remain nearly 30% higher than its average level of 1990 to 2005—a period when housing starts averaged 1.52M. We believe there are two drags on the economy that are more important than affordability.
First, there is the issue of tough lending standards. Data from Fannie Mae show that credit conditions tightened
sharply after 2007 and have remained tight since. For example, in 2007, more than 37% of mortgages purchased by Fannie Mae had borrowers with a credit score below 700. The figure dropped to 8.4% in 2009 and has increased to only 14.5% in 2013. The average FICO score for a Fannie Mae-backed mortgagee was 717 from 2004-2007 and 760 from 2009- 2013 (Graph 1).