The financial strength of US homeowners is a cushion against a downturn


As the housing market enters its third year of sales recession, it is notable that home prices have generally kept climbing, except in a few key markets. It has been such a difficult sales market that one might wonder if a significant national home-price decline is in the cards. To understand that hypothesis, let’s examine the factors that might lead to further decline or an outright crash in home prices. 

When analyzing the future of home prices in this country, and the potential for a home-price crash, or distressed sellers flooding the market if/when a recession finally catches up to us, we should look at three variables. Foreclosure happens when all three of these variables are true:

  1. Payment: I have lost my job and I can no longer afford my mortgage payment.
  2. Terms: I am upside down on my loan or I have onerous terms.
  3. Market: I am unlikely to be able to sell my home because there are too many on the market that aren’t selling. 

When a person finds themselves no longer able to afford their mortgage payments (No. 1 above), they either have to find new income or sell the home. Prolonged unemployment is a first requirement for this process. As of right now in America, unemployment is still very low, though this could change quickly. Unemployment is inching higher. 

If I realize I must sell the house, and I’m met with very weak market conditions (No. 3 above), for example rising inventory and long days-on-market, I get discouraged about my ability to sell. I may go into foreclosure before I can sell. 

And in fact, inventory of unsold homes in the country is up 40% over last year. That seems like a lot, but that’s still only about half the number of homes on the market than were available 10 years ago (with some exceptions, such as Austin, Texas, which has more inventory than 10 years ago). Many areas in the Midwest and Northeast have inventory levels which are climbing this summer but are still just barely above the pandemic-led record lows. Most markets across the are still relatively restricted in terms of available homes for sale. 

So that leaves us with the mortgage loans (No. 2 above) themselves. If a big recession is going to trigger a flood of inventory, with enough newly available supply of homes for sale to grow out of balance with the limited demand by homebuyers, that flood will be triggered by underwater borrowers or onerous terms on the loans. Let’s take a look at what we know about American mortgages right now.

At the end of the pandemic, American homeowners had the best deal ever on their mortgages. In the first quarter of 2022, just before interest rates started rising, 85% of mortgages carried an interest rate less than 5% for a 30-year fixed rate loan. But now that we’ve had two years of rising interest rates, those dynamics are slowly changing. 

The incredible financial benefit of ultra-low mortgage rates is waning each month as a few older, low cost mortgages get paid off and approximately 400,000 home purchases happen with higher-cost mortgages. Now, only 76% of American mortgage holders have an interest rate below 5%, down from that 85% level two years ago. 

As of the end of March 2024, 21.9% of American mortgage holders have an interest rate under 3%. That’s declining by 20-30 basis points per quarter as those mortgages get paid off.

Mortgages with slightly higher interest rates are slightly more likely to be paid off each month. 35.4% of mortgages hold an interest rate under 4%. There are 30-60 basis points fewer each month.

In the above illustration of mortgage interest rates distribution, two takeaways: first, the significant percentage of homeowners with rates under 4%. Even in a prolonged economic downturn, these borrowers will remain in powerful positions. At such time as market returns on money, for example the 10-year Treasury, pay less than 4% interest again, Americans will continue to keep the balance on these cheap mortgages.

The other observation here is that probably two more years with mortgage rates in the 6s-7s will bifurcate the borrowers. We’ll have as many borrowers with higher cost mortgages as we did 10 years ago. As homeowners with high mortgage rates are more likely to sell their homes, rising rates leads to rising inventory. That implies that after two more years of higher mortgage rates, we’ll have nearly as much available inventory of homes for sale as we did a decade ago. We’ll be able to measure this gradual shift in homeowner financial position in the number of homes for sale at any given time. 

Equity

If you’re not looking at the data, it can be hard to comprehend just how much equity Americans have in their homes and how important that is for their financial well-being. According to the FHFA national mortgage database, only 0.3% of borrowers have negative equity in their homes. If you bought a home in Austin in June of 2022 and used only 3% down payment, you may be upside down now. That’s scary for those borrowers, but that situation is very rare.

If we average the loan-to-value ratio across all the loans in the country, we see a dramatic improvement over the last decade. In 2013, nationally, we had a 70% loan to value ratio on outstanding mortgages. Now, after a decade of dramatic home-price appreciation and an expanding economy, mortgage holders in America have only 48.3% LTV. 

These are huge improvements in borrower strength to shield against a prolonged downturn in home prices. In a scenario where unemployment spikes due to a recession, those millions of workers are buoyed by hundreds of thousands of dollars in home equity. 

This benefit is generally distributed across the country, but some states have grown equity more than others. The states with the most strength might surprise you. Here’s that decade-long improvement in LTV mapped by state.

For example, in 2014 the average mortgage holder in Florida carried a loan with 74% LTV — that’s 26% equity. As of Q1 2024, the average mortgage holder in Florida has only 47% LTV, a huge improvement of 27%. That’s equivalent to over $100,000 on a typical home in Florida.

Even as the economy perhaps finally slows, and even as mortgage rates stay higher for longer than anyone expected, the housing market remains buoyed by an incredible cushion of very strong borrowers. These optimal mortgage conditions provide a blanket of security for any future downturn in the housing market.



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