After a crazy decade, the housing market will likely become boring again -- but that's a good thing!
Over the past decade, the U.S. housing market has been on a roller coaster ride. Home prices rose at an unprecedented rate during the boom years. They then fell precipitously when the bubble burst. In 2011, prices are expected to decline further, as the market continues to search for a stable bottom. What's in store for the American home in the years to come?
The Good Old Days
Before the 2000s began, buying a home was a pretty straightforward process. At that time, there was little excitement gripping housing market. Americans with a moderate income could save up to make a reasonable down payment. Then, if their credit was good, they could obtain a mortgage from a bank. They paid their mortgage for 30 years or so and eventually owned the home. Many would sell the home in time, using the money for retirement after downsizing.
But as the 21st Century got under way, something happened. Credit was kept cheap for an extended period. At the same time, some investors had become wary about stocks after the tech bubble burst. Global investors also wanted to find safe U.S. investments for their money. With better computer technology, mortgage-backed securities became easier to quickly structure and sell. These and a few other forces combined to create a huge flow of capital into the U.S. housing market.
As this investor money came pouring into the sector, banks needed more and more mortgages to back securities that would satisfy the rising demand. Banks pursued borrowers more and more aggressively. Credit standards began to decline as a result. Few people were denied mortgages. Not only did down payments become seen as unnecessary, but some mortgages effectively paid borrowers at first through negative amortization. Other lenders created new mortgage products that appeared affordable at first to borrowers, but reset to payments they could not afford in future years.
Due to all of these efforts to conjure up home buying, purchases ramped up to a rate never seen. They drove up home prices up by double-digit annual percentages in some regions. Starry-eyed market observers claimed that there had been a paradigm shift in residential real estate in the U.S. Even long-time homeowners got into the game by refinancing and cashing out some portion of their equity. Others took out home equity loans. Some people used this money for a noble purpose, like paying their the college tuition of their children, but others spent it frivolously on luxuries like vacations.
In this new market, just about anyone with a pulse could buy a home. Most people could even buy second homes. Home ownership rates rose to historic highs. Meanwhile, nobody much worried that the boom was out of control, because people believed home prices wouldn't decline.
The four horsemen of the mortgage apocalypse: cheap credit, better mortgage technology, declining standards, and willing buyers
There's an adage that says, "Whenever something seems too good to be true, it probably is." The housing boom followed this rule. Most of those mortgages based on wacky new products or provided to borrowers with flawed credit backgrounds began going bad. Not only did this cause the housing market to collapse, but reverberations were felt across the financial industry and world. Credit virtually froze, and a deep recession began.
Over this period, home prices plummeted as foreclosures and distressed sales rose at unprecedented rates. Owning a home became a curse instead of a blessing to many. Even some homeowners who weren't involved in any of the boom-time antics saw the wealth that had accumulated through their home equity wiped away.
Today, in 2011, we remain in this phase of the narrative. Prices stabilized temporarily in 2009 and part of 2010, as the government's home buyer credit pulled forward some future demand, artificially raising home sales. But after it expired, prices began falling again, as the market resumed its search for an elusive bottom. Once most foreclosures and other distressed properties are purchased by borrowers who can afford them, the sector will stabilize.
The Good New Days?
Many analysts think that prices will stop declining sometime next year. Once foreclosure activity slows down to historical norms, the future will look a lot like the more distant past. Americans who had purchased homes with dollar-signs in their eyes will once again view buying a home like they did in the 20th century. The American home will no longer look like a rapidly growing pot of gold, a high-return investment that could never lose money, or an ATM. Instead, it will be once again seen as a place to live where a family can build equity over the years, and save some money by not paying rent.
But the boom and bust had significant consequences. The conditions that caused the boom were built up over decades. The U.S. government had a hand in creating some of the problems that led to the bubble. It underpriced mortgage guarantees through government-sponsored enterprises Fannie Mae and Freddie Mac. It also allowed their underwriting requirements to weaken. Easy credit policy was partially to blame as well. The beloved mortgage interest deduction also played a part in making homeownership seem like a better value than it actually was.
In 2010, Congress took some action to create new financial regulations, but few of them had significant implications to housing. One, however, will result in a new qualified mortgage standard that will likely result in some banks preferring larger down payments. Banks themselves have already tightened lending standards, putting home ownership out of reach for some Americans with relatively low incomes or imperfect credit histories.
This year, policymakers in Washington will take further action to reform housing finance policy. One of their biggest targets will be Fannie and Freddie. Their wind down will begin. In October, the maximum mortgage size that they can guarantee will decline. As time goes by, their presence in the housing market will slowly diminish.
The big question that remains is what role the government intends to play in the mortgage market going forward. Due to the fear of another boom and bust cycle like the last one, it's somewhat likely that its influence will be reduced. The government will likely continue to have small programs to promote homeownership for some low- to middle-income Americans. Beyond that, however, its further support for the residential real estate industry may be limited to catastrophic or emergency loan guarantees. Deficit concerns may also result in Congress rethinking how the mortgage interest deduction works. It's too politically bullet-proof to be eliminated entirely, but it may be revised to exclude wealthier Americans.
The American home's future will look like its past: a symbol of hard work, discipline, and responsibility.
In time, banks will generally require mortgage borrowers to have near-spotless credit histories and to provide a reasonable down payment. Their income will have to be relatively stable and clearly support the monthly payment associated with their mortgage. And that payment may include more interest than it used to, as mortgage interest rates will rise somewhat if the government limits its role in housing finance.
So what will the American home look like in the future? It will become a symbol of hard work, discipline, and responsibility, just like it was in the past. That might make buying and owning a home a little more boring than it was over the last decade, but when it comes to the biggest purchase most Americans will make in their entire lives, too much excitement can be dangerous.