Millions of homeowners trapped in entry-level homes for over a decade
With housing markets only now reaching the peak of the housing bubble, many have been trapped in their homes for over 10 years.
In 2005 most people who bought their first homes believed they won the lottery. In the five preceding years, house prices more than doubled, and since most people extrapolate short-term price movements to infinity, most homebuyers in 2005 believed they were on their way to being billionaires.
It didn’t work out that way.
Most people who bought in 2005 are only now above water — and that assumes they had an amortizing loan and dutifully made all their payments. Those with loan modifications had the fees and missed payments tacked on to their mortgage balance, and many (if not most) private loan modifications don’t amortize, so those borrowers are likely still underwater. Those borrowers are still trapped in their entry-level homes 10 years later.
For many homeowners, the last ten years in borrower purgatory felt more like borrower hell, trapped beneath their debts. Any remedies for their situation carried negative consequences. Many people opted to strategically default, and I openly encouraged this action for years because it immediately relieved the emotional distress and put people on a path toward building a new future. However, those who strategically defaulted had to pay a price of a lowered credit score and lingering debt collection issues. Many others borrowers opted to sell short, but this too had credit implications. A few even sold the house and paid the shortfall out of savings, but these sellers were the exception rather than the rule.
By far the majority of these people are still trapped in their entry-level homes. Many obtained loan modifications, but many others struggled to make sky-high mortgage payments, and they struggle to this day.
Houses are expensive. Most renters who would like to buy a home lack the down payment necessary, and many are early in their careers when their income is lower. As a result, first-time homebuyers must purchase the lowest-cost properties available for sale in the housing market, and they must use the highest-cost financing options due to their low down payment.
Most first-time homebuyers use an FHA loan and buy a low-cost property. The reason for this is simple: it takes too long to save 20% for a down payment on a conventional loan. First-time homebuyers use FHA loans because the 3.5% down payment is within reach. Further, once these buyers are in a property, they wait five or ten years for the wage-based appreciation to magically give them 20% to 30% equity in a property to use on their move-up purchase. (See: Renter’s guide to preparing for home ownership)
With 20% down, the first move-up buyer has access to lower-cost conventional financing, and since several years have passed since their first purchase, they often have a higher qualifying income. Combine these two factors, and first move-up buyers can outbid first time buyers by a significant margin, and they ignite the chain of move ups that reverberates through the market.
Lack of move-up equity
Despite the fact house prices moved up 50% or more since early 2012, this hasn’t created a large number of move up buyers because a relatively small number of buyers participated in the market while prices were low.
The majority of those who bought between 2003 and 2010 are either underwater or just barely above water and unable to execute a move up. Those that bought in 2014 and 2015 haven’t acquired enough equity yet as prices haven’t moved much higher.
This lack of move-up equity and lingering problems with underwater borrowers explains the unusually low levels of for-sale housing inventory.
While reflating the housing bubble has done much to alleviate the plight of underwater borrowers, it’s created a secondary problem that’s a direct side effect. By inflating house prices well above trend, many first-time homebuyers are priced out, and many others are concerned about buying into another housing bubble.
Back in 2013 I wrote the Housing market impact of 25 years of falling mortgage interest rates. In that post I noted, “House prices have been boosted about 30% due purely to the decline of interest rates from the mid 90s to today.” This artificial inflation of prices shows up in charts like the one above and the one below.
So while one generation is no longer trapped, the next generation isn’t eager to become their bagholders. Potential first-time homebuyers fear rising mortgage rates will cause another house price crash — or at best result in below-average rates of appreciation while the 30% overvaluation of the market is caught up to by fundamentals. It’s a rational fear, a fear keeping many first-time homebuyers out of the market. In fact in 2014 the first-time homebuyer rate hit a three-decade low. Millennials, those born approximately between the early 1980s and early 2000s, who will soon become the majority of the workforce and the next generation of homebuyers.
The Millennials currently cope with excessive student loan debt, which is also preventing them from buying houses. Millenials are delaying marriage, and they are not forming new households at the same rate as previous generations. Most housing market analysts blithely assume Millennials will follow the same path as preceding generations once they have opportunity, but what if Millennials decide not to buy homes? Baby Boomers don’t want to think about that possibility.
What happens to the housing market if first-time homebuyer rates fall to record lows and remain there for many years? Over the next decade, we’re going to find out.
Perhaps an improving economy, strong job growth, and strong wage growth will cause house prices to rise as much over the next 25 years as they did for the baby-boom generation. If mortgage rates remain permanently below 4%, that could happen. But how likely is that?
Due to the stability in housing brought about by Dodd-Frank, I don’t believe today’s homebuyers have much to fear, but that same stability means prices won’t shoot up wildly like past bubbles either, so today’s homebuyers don’t have much to gain. Buying a house as a family home is still a good idea. It’s reverted to the old stable and boring retirement piggy bank it used to be. And in my opinion, that is a good thing.