Ben Kono, Lead Realtor with My SMART Team at EXIT Realty 1st, brings historical perspective to the current housing market, so you can make SMART real estate decisions.
The Real Estate market of 2007 was amazing! Houses were flying off the shelf, prices were rising more quickly than anyone could keep up with and it seemed like anyone could start living the American Dream, owning their own home.
A few short months and it seemed like a switch flipped. Houses were growing stale on the proverbial shelf, prices plummeted more quickly than we could keep up with, and banks weren’t writing loans to anyone! The American Dream, short lived by so many, was over.
Fast forward to 2021. Houses are flying off the shelf, and prices are rising just as quickly as before. But is this a foreshadowing of a coming disaster? Will history repeat itself (or be even worse this time)?
To the untrained eye, real estate is doomed to fail yet again. It looks the same as 2007, and sounds the same as 2007. It must be the same as 2007.
But what if it’s not?
What if things really have changed? What if we learned from our mistakes? What if we’ve got it right this time?
TOP 3 REASONS THE BALLOON BURST IN 2007
Ok, so we all know that low interest rates are great, but how do mortgage interest rates set the stage for a market failure?
Think about this: You purchase a $300,000 house. Your down payment is pretty small so the total amount on your loan is $290,000. That’s not bad, honestly. People buy houses with 3% down all the time now.
ADJUSTABLE RATE MORTGAGES
Here’s the sticky part: You have an ARM (Adjustable Rate Mortgage) and you can really only afford the house at your current interest rate. What happens if your rate goes up?
For a $290,000 loan at 4% your monthly payment (just principal and interest) is $1,382. You can afford $1,400 with little issue. It’s a bit of a stretch but you’re going to make it work. However, if you have an ARM, your payment won’t stay there. It could go down, but that’s not what happened in 2006-2007.
So the reasonably affordable payment turned into a stretch at 5% ($1,554) then a burden at 6% ($1,735) and became impossible at 7% ($1,974). This was far too common in 2007.
The added element with ARM’s is that they are like ships on the ocean, and the PRIME RATE is sea level. The prime rate is the underlying index for most credit cards, home equity loans and lines of credit, auto loans, and personal loans. In 2006 and 2007 prime started to rise. It brought all the mortgage rates with it and houses rapidly became unaffordable, eventually bursting the dam and bringing a flood of foreclosures to the market.
I know what you’re thinking and you’re right. A few foreclosures honestly can’t break a market. People go through foreclosures every day. So here’s the next layer. Values were inflated beyond the capacity of the market.
Ok, but that’s happening now too, right?
In 2007 lenders and appraisers had a direct line connection. Appraisers were incentivized to meet a specific value and lacked regulation from a third party. The lack of supervision combined with incentives was enough to cause most appraisers to inflate property values.
Honestly, inflated real estate value isn’t a problem if the borrower/purchaser is able to repay their debt. But when values are inflated and, for a variety of reasons including ARMs and job losses, borrowers begin defaulting on their loans.
This was the scene in 2007. Property values were high, banks were foreclosing left and right and were trying to sell their assets to make back the debts they were owed.
You may be thinking, that’s not so bad. The banks still get to make back their money! They sell the house and, even if it’s not 100% of the debt owed they are still making a good chunk of change! Right?
Let’s examine the final element of our 2007 catastrophe and then we’ll look at why 2021 is different
BAD LENDING PRACTICES
This is the largest factor contributing to the crash of 2007.
Have you ever had to get a loan? Let’s say you want to buy a car. What do you have to prove? You have to prove that the car is worth at least what you’re paying for it. The same is true with your home.
Let’s look at the rest of the lending process. Once value is established, before you get any money, the lender will verify a few more things.
First, that you exist. That you are a real person. This was not the case in 2006-07.
Next, that you make money, enough that you can comfortably make the mortgage payment AND other debts you have, like a car loan. This also was not the case.
In 2006-07 lenders would happily loan money to shadow entities that didn’t have any income. They would lend money to an individual based on what they SAID they made without asking for pay stubs or tax returns to back up those claims.
WHAT’S DIFFERENT NOW?
So much about 2021 is similar to 2007 on the surface. Prices are rising, houses are selling above asking price, and get multiple offers right away. So why does this realtor have confidence that we won’t see another market crash?
Let’s look at lending first.
On the consumer end, 99% of loans written today are FIXED Rate Mortgages, this means most homeowners will NOT experience a foreclosure-causing payment increase.
Next, the policy side.
Lenders are now required to vet buyers thoroughly. They have to prove the buyer exists, that they have real, predictable income, that they aren’t over-leveraged with other debts, and that they’re highly likely to make their payments.
The final factor is HOW prices are rising. In 2007 lenders were writing loans for 100%+ of the value of a house. Now, prices are climbing with health, supported by an appraisal and lower loan-to-value ratios (meaning buyers are bringing larger down payments so if the loan defaults the bank isn’t crippled).
So, is the market at risk for a crash? No! It is true that the inventory of listed homes is currently low. But we learned from the crash of 2008 and made positive changes to the financial regulatory system. These changes will protect your investment in your home for years to come!