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March 11, 2021

The Return to a Normal Mortgage Market

How will we return to a normal mortgage market in 2021? This post provides some of the risks the industry faces as we return to a more normal mortgage market cycle.

How might we return to a normal mortgage market in 2021?

Knowing exactly when something will happen is not as important as knowing that it will happen and being prepared when it does. We know the current mortgage market is not sustainable. Whether we’ll see a mortgage market crash in 2021 has yet to be determined. What we need to do now is make sure that our companies and our borrowers are prepared if it does. 

As the market normalizes, especially in terms of agency production, we can expect rates to tick upward. This will have a calming effect on home buying and mortgage volumes will fall. I certainly do not anticipate anything close to a crash, but a correction is imminent. 

You don’t have to own a crystal ball to know this is happening. In fact, some are seeing evidence of a slowing market now. The Fed said in January that it’s already seeing growth slow

In response the FOMC said it would hold its benchmark short-term borrowing rate close to zero and keep buying assets at the rate of $120 billion a month. The Fed’s efforts should be applauded, but they can’t last forever. And it could lead to an unfortunate result. 

Eventually, COVID will become a memory, wages will rise as unemployment falls and rates will tick upward. The impact this will have on lenders will be significant, but the effect on homeowners could be far worse. 

A normalizing housing market 

Others have written volumes about the negative impact that rising interest rates can have on a lender’s business. We all know about the near future death of the refinance business, a return to a purchase money market and increased competition among lenders. In this post, I want to talk about the impact this could have on homebuyers. It has to do with home prices. 

There are plenty of reasons to believe that home buyers who buy now, at the top of the market, could face challenges in the near future when home prices soften. 

Prior to the credit crisis, lenders knew that every time interest rates went down housing prices would rise, and vice versa. It was a predictable cycle that used to manage many mortgage lending businesses. That changed with the credit crisis of 2007-2008.  

In the wake of that crisis, interest rates fell, but because there was so much inventory on the market thanks to the foreclosure crisis, home prices didn’t rise in response. The Fed held rates down to help get the economy back on track, but homes were still very affordable. 

A decade later the normal cycle was still disrupted. We saw both interest rates and housing prices rise, the first due to a stronger economy and the second due to falling inventory. Then COVID struck and knocked the industry back into a normal cycle. 

In today’s market, we see home prices rising and interest rates lower than ever, which is what we would expect. But for many home buyers, this could pose a problem. 

Keeping homeowners above water 

In a normal housing market, as rates go up housing prices should yield and get softer. This means that people who are buying homes now are buying in at the very top of the market. Even though this is a tremendously opportunistic time to buy a house due to low interest rates, that fact has to give them pause. 

The homes being sold today may not appreciate quickly. They may even lose value. That could be bad for homeowners. There is some evidence that consumers already realize this.  

In a recent survey by LendingTree, nearly half of Americans said they believe the housing market will crash this year. Another 22% felt the end would come next year in 2022. Either way, American homeowners realize that this market is not sustainable. 

But do they realize what will happen if home values fall? 

Millions of homeowners found themselves underwater on their mortgages just a decade ago as the industry worked through the financial crisis. Could this happen again? Yes, and it could be worse. 

New higher FHA loan limits could put many new homeowners at risk of owing more on a mortgage they put 3.5% down on than their house is worth if prices fall. 

The problem could gain significant additional scale if Non-QM lending continues its comeback and we don’t see thoughtful lending and careful underwriting in that market. 

Another reasons home prices may fall 

Of course, rising interest rates isn’t the only factor that drives down home prices. Inventory levels also play a major role. Most experts expect the industry to see a glut of home inventory about 15 years from now as the Baby Boomers exit the playing field. 

What COVID did was speed up that timeline, some say by as much as 12 years. This means that inventory levels could change dramatically in 24 months, driving home prices down. 

Thinking about potential changes in the market before they happen is what keeps leading lenders out in front, both of the business and of their competitors. If you’d like to have a conversation about these things and find out more about things you can do now to prepare your company for a future like the one I’ve described, reach out. I’d love to visit with you. 

By Joe Camerieri, EVP, Client Account Management at Mortgage Cadence

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