It’s been five years since the financial system collapsed and the housing bubble burst, and it's been a long road to recovery. The housing market has only been on the mend over the last year, and according to experts, it still has some healing to do.
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“There are still many homeowners who are underwater, there are still many foreclosures in the pipelines, and there are still too many folks whose access to credit is still impaired,” says Keith Gumbinger, vice president with HSH Associates.
But we've come a long way.
New home sales hit their highest level since May 2008 in June, fewer homeowners are underwater and home prices in the country’s 20 largest cities were up 12.1% in June from a year earlier.
“Right now, I would say we are 64% back to normal and a lot of what is driving the housing market’s strength is existing home sales, but prices have also helped push the recovery,” says Jed Kolko, chief economist for Trulia.
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Sales of new U.S. single-family homes vaulted to a five-year high in June, according to the Commerce Department.
According to Jed Smith, managing director of quantitative research at the National Association of Realtors, home sales stood at 4.2 million in 2010, and he predicts a rise to 5.1 million by the end of this year. “We continue to see good sales, we expect them to increase 5% next year as prices continue to rise. The market isn’t fully running on eight cylinders yet, but we are getting there.”
Existing-home sales are only off by 2% from normal levels, adds Kolko, but construction starts are the recovery’s biggest hurdle -- off by 40% of normal activity. “There is a drop in the creation of households, young adults are moving back in with their parents or living with roommates a lot longer before striking it out on their own.”
According to Pat Newport, an economist for IHS Global Insight, housing starts need to be closer to 1.4 million in order for shortages to ease, and it takes about eight months to build a single-family home.
“When the housing bubble burst, construction levels collapse and stayed at historic lows for four and half years,” Newport said.
“The key lesson we learned is that housing prices can fall. No one seemed to think that leading up the bubble burst. That was the reason for the whole mess, and now we know better.”
Steady home sales and new construction is not only important to the housing market, it’s a boon to overall economy. “For every two home sold, a job is created,” says Smith. “New home construction brings in three jobs for every house build.”
Housing experts say U.S. home prices peaked in early 2006 and fell to record lows in 2012. The widely-watched Case-Shiller home price index fell to its lowest level at the end of 2008.
Smith says home prices began to improve in 2011 when the market had almost digested the crisis and left the average median home price at $166,100. Now he says the average price is $213,500 -- up 15% from last year.
Rising prices will also help maintain the recovery because it changes a homeowner’s mindset. “Someone who is 5% underwater in an environment of falling home prices might be discouraged and more likely to walk away from a mortgage; if they are underwater but home prices are rising, they are more likely to stick it out,” says Kolko.
The importance of homeownership has faded over the last five years as consumers’ shy away from the idea that real estate is a sound investment. Newport says the homeownership rate shot up in 2005 to 69%, and is now around 65%. He expects the rate to fall to levels not seen since the 1960s.
“The key lesson we learned is that housing prices can fall. No one seemed to think that leading up the bubble burst,” says Newport. “That was the reason for the whole mess, and now we know better.”
Smith from the NAR says during the height of the crisis, distressed sales, which include foreclosures and short sales, made up 49% of the market. Now, that number is closer to 12%. Last week, RealtyTrac reported foreclosure filings fell 34% in August as first-time defaults dropped to the lowest level in almost eight years, thanks to rising home prices.
The foreclosure process varies by state, and those that involve going to court draw the process out, making it harder for foreclosures to work through the system.
“In states where you don’t have to go to court, the rate is around 2% right now, but in the court-involved states, the rate is still high since it takes two to four years,” says Newport.
Smith says about two million foreclosures still need to work their way through the system.
“They are going to be with us for awhile, but there are government programs trying to slow that and as home prices continue to rise, that will also bring people out from underwater and help prevent more defaults.”
Long gone are the days of easy lending that allowed prospective homebuyers with bad credit and shaky financials to qualify for a mortgage. These subprime loans carried higher interest rates than normal loans because the lender was taking on more risk. According to reports, close to half of the loans issued in 2006 were subprime, and when the economy took a hit and people started losing their jobs, home prices dropped and homeowners started defaulting en masse.
In the years following the bursting of the bubble, the credit markets essentially froze as banks became more risk adverse after getting burned by loose mortgage practices.
“We’ve experienced a near full reboot of mortgage lending standards, back to those commonly seen in the ‘70s and considerable portions of the ‘80s and ‘90s,” says Gumbinger. He says lending practices loosened around 2006 as home prices seemed to be on an endless rise. “Rising prices means that the risk of making a loan to even a poor-quality borrower diminishes over time. When sales slumped due to higher rates in 2006 and ARM resets drove up costs, there was nothing left to keep the price bubble inflated, and when it popped and prices fell, losses spread like wildfire."
According to Smith, currently 55% of homebuyers qualifying for a mortgage have a FICO score higher than 740. In normal conditions, that number is closer to 40%. “Standards are still too tight for a normal market. If banks loosened up we could probably see an increase of half of million home sales a year and that would significantly help the market.”
The housing market’s strong expansion from 2000-2006 caught Wall Street’s eye and financial institutions created new mortgage instruments, including mortgage-backed securities, to help get a cut of the action. Exotic new loans that extended beyond the normal 30-year term were also introduced.
“The loans that got us in the most trouble aren’t very common today,” says Kolk. “You don’t really see loans longer than 30 years or interest-only loans.”
Where We Go From Here
Housing experts and financial institutions are keeping a close watch on looming legislation regarding lending practices that will set the tone for future market activity.
“Legislators are in the process of debating the financial risks for different types of mortgages and how they can protect consumers without getting too involved in the normal activity of the housing market,” says Kolko.
In January, the Consumer Financial Protection Bureau issued regulations detailing how lenders must ensure consumers can afford any loans by verifying their income, employment, and total debt -- which cannot exceed 43% of income.
The future of government-sponsored enterprise’s like Fannie Mae and Freddie Mac remain murky. The government has mulled shutting down tor trimming back the companies, but exactly how to reshape them has proved difficult.
“Without them, what comes next?" asks Gumbinger. “There's no way to know at present what the mortgage markets of the future will be, and that will determine to a large degree what kinds of financing are available, to whom, and at what sorts of terms, conditions and costs. It is access to mortgage money, although not necessarily always price, which can drive the housing market.”