How do you hurt a market that has already collapsed? You prevent it from recovering. That might be a consequence of regulators' plans to impose higher down payment requirements on banks that do not want to hold a portion of the mortgage risk that results from home sales. Could this move slow the healing process of housing markets in the worst-hit regions?
Business service analytics firm CoreLogic thinks so. In a report issued earlier this week, it analyzed the negative equity status of the U.S. housing market. The results were ugly. But separately, its report also noted:
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 set forth the qualified residential mortgage (QRM) designation, which exempts lenders from risk retention requirements for the loans to be securitized, making those loans cheaper to originate. While there are many aspects to the definition, an emerging consensus is that a 20 percent down payment will be one of the features. Clearly, higher down payments are necessary to reduce credit risk for lenders and securitizers, but given the majority of homebuyers are repeat buyers who use current equity as the bulk of their equity, states that have a lower proportion of borrowers with 80 percent LTV or less will be adversely affected because repeat buyers will not have sufficient down payments to buy new homes with QRMs.
This new requirement was discussed last week in a Congressional hearing. CoreLogic argues that potential buyers will have relatively more trouble scraping together enough cash for a 20% down payment in the hardest-hit regions, since their home equity has been more adversely affected by the housing market's collapse.
Does this make sense? The situation CoreLogic refers to here would be an existing home owner selling his or her current house and purchasing another house. This would only create churn in the market -- it would not reduce housing inventory. One home is added to inventory as another is taken away, so the sale would have no net effect on inventory. In these markets, the key to healing is getting their home inventory back to lower levels. Then, buyers and sellers would more easily match up, minimizing the need for deep discounts by desperate sellers
There are two types of buyers who can reduce inventory: those who don't already own a home and those who are buying a second home. In the first case, home equity is obviously irrelevant, since this person must be a renter. In the second case, equity could matter if the home owner intends to obtain a home equity loan to afford a down payment on a second home. It's hard to believe that this practice would be very common, however. Most people who buy a second home would have enough wealth to provide for a down payment without having to dip into the equity in their primary residence. Otherwise, they probably shouldn't be buying a second home anyway.
Although CoreLogic's reasoning isn't quite right, its conclusion might still hold. The negative equity capitals also generally tend to be epicenters of high unemployment. For example, Nevada, California, Florida, have unemployment rates of 14.2%, 12.4%, and 11.9%, respectively. Arizona and Michigan have lower rates, but they are still well above the national average of 8.9%.
If a region has more jobless residents, then it also has a smaller pool of potential home buyers. Even after these individuals find jobs, they aren't likely to have enough cash lying around to put 20% down on a new home. For many people, when they experience a job loss, they are forced to dip into their savings to continue paying their bills. As a result, the individuals living in these regions have likely experienced a disproportionate decline in personal savings, due to their high unemployment rates.
Of course, none of this necessarily neutralizes the need for a 20% down payment requirement for mortgages. It's sensible for banks to require higher down payments than they did during the boom for mortgage market stability. But the requirement may have the unintended consequence of making the road to recovery a little bit rougher for the regions struggling most. If it's any consolation, the more their home prices decline in those areas, the easier it will be for prospective buyers to afford 20% down payment requirements.
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