Despite talk about housing bubbles in the media again, there are several key differences between today’s market and the price surge of 2005. Here are four reasons why we an still be confident in the current market:
1. 100% Financing vs. Down Payments
2005: 100% financing was easily attainable for investors and consumers alike with little verification of income. This reduced the risk for investors. With none of the investors’ money invested, the lenders took on all the financial risk when the investments failed.
Today: 100% financing is scrutinized. Most investors have purchased with cash in last 7 years, and most borrowers are required to contribute a down payment. As a result, if there is a downturn in appreciation, equity positions will encourage homeowners to stay put instead of abandoning their investment.
2. Adjustable Rates vs. Fixed Rates
2005: Adjustable rates and interest only payments were rampant between 5.5-6.5%, available at purchase or through refinancing. When interest rates rose, consumers’ payments rose with them to unaffordable levels. Since all of their payments went to interest instead of equity, many owed more than their home was worth and were forced into foreclosure instead of selling through traditional methods.
Today: The majority of loans issued are fixed between 3-4%, either through purchase or refinance over the last 6 years. If rates increase, these interest rates and payments will stay the same. Payments include both principal and interest to ensure a build up of equity. This, combined with positive appreciation over the past 6 years, provides a significant equity buffer to weather a potential downturn and reduce the risk of abandonment.
2005: Appraisals and appraisers weren’t scrutinized by lenders, removing a significant barrier to unsustainable price appreciation. Many appraisers were uncharacteristically liberal in their valuations as they were dependent on referrals from the real estate community, not the underwriters.
Today: Appraisals are highly scrutinized and appraisers are conservative with valuations, creating a resistance to unsustainable, unverifiable appreciation. Appraisers are chosen by the underwriter, not the borrower or any commissioned party dependent on the close of the sale. This removes any undo pressure on the appraiser to value the property at contract price.
2005: Investors purchased homes with no intention of living in them or renting them out, often selling vacant properties amongst themselves at soaring profits with no monetary investment on their part.
Today: The vast majority of homes owned by investors are either free-and-clear or have significant equity. Instead of being vacant, they are rented and providing cash flow. The fear of investors “dumping” their real estate investments en masse and abandoning vacant properties is irrational when vacancy rates are at historical lows . There are few reasons for an investor to abandon a free-and-clear property while it’s generating income.