Homeownership Rate - Past, Present, and Future
This is the second post in our homeownership rate trilogy. Our first post reviewed the history of homeownership rate and how it went from 46.5% between 1890-1930 to a steady 65% in 1970 and onward. In this post we focus on the now, looking at homeownership not only from a homeowner’s perspective, but also from that of lenders and real estate financing in general.
Part 2: The Present
The first step towards change is to know your history, so you can avoid repeating it. But the second step is sometimes a little more tricky, and that’s market research. It takes time and resources, but you need to familiarize yourself (to say the least) with your current surroundings before you can go ahead and create something new, let alone convince everyone your idea is worth a shot.
Today in the US, homeownership rate is at 65%, the same as it was over 50 years ago. If we go back again to the chart from Don Layton’s mass “The Homeownership Rate and Housing Finance Policy”, we see something quite interesting - homeownership rate is extremely stable. From the 1970’s until today the rate is holding steady around 65%. During a timeframe of huge technological advancements, political leadership swings, economic booms and recessions, even wars - nothing seems to make a real dent in the homeownership rate.
Even the housing bubble that formed in the early 2000’s and popped later that decade is only a mere 2% blip which quickly returned to the norm. This demonstrates just how sticky the homeownership rate is - to the extent that even the housing bubble of the 21st century couldn’t change it for more than a couple of years. Want more? Even the pandemic, a once in a lifetime global event, couldn’t touch it. Why is that? And is it connected to the various types of mortgages available?
Since housing is financed with mortgages, we need to explore this relationship deeper. We’ve already covered the birthing process of the 30-year fixed-rate mortgage, aka the “American Mortgage”, and how it became the dominant mortgage product. Now it’s time to ask why no other mortgage product challenged its dominance in the past 5 decades.
In the book “Guaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage Finance” (by Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh, and Lawrence J. White) we learn how Fannie and Freddie started their race to the bottom, following the implicit promise from the government to securitize their entire debt. It was that exact promise that led them to grow bigger and bolder than ever before - without any room for any other type of agency to flourish, since no one else was securitized in such an undisputed manner.
While the mentioned debacle was the result of irresponsible real estate financing, when reading this book, one can’t help but wonder what would have happened if diversity and social responsibility were practiced not only in various types of mortgage products, but also in various types of agencies that securitize it. Would there have been a way to stop the debacle from happening? Nip it in the bud? Avoid it altogether?
15 years later, we are faced with another struggle in the housing market, but while interest rates rise, the market now seems more resilient and healthy: no toxic loans (thanks to the Dodd-Frank Act), and many solutions for those who find it difficult to get a traditional loan for any number of reasons. Here are some of the solutions out there today for those who can’t afford a traditional loan, but strive toward homeownership, even if it means using a service with a completely different business model:
Rent-to-own - a company buys a home for you, so you can rent it from them, and maintain an option to buy them out in the future.
Fractional ownership - allowing micro investments and connecting multiple investors with potential homebuyers looking for real estate funding. As in 1, you pay “rent” for the portion funded by the investors.
Home equity - giving homebuyers a way to meet the 20% down payment needed for a traditional loan by taking capital from equity investors.
So everything is good, right? We’re ready for the next hit wave? Sadly, no. None of the solutions above is considered as an actual alternative to the 30-year FRM that dominates the market. While agency loans generated home loans at a yearly rate of over $4T in 2020, all other services mentioned above were merely a few billions, combined. That’s a fraction of the market.
Let’s take a closer look at the current GSE product line:
15-year & 30-year Fixed Rate Mortgage - the “American mortgage”. A home loan with an interest rate that’s set for the entire term and includes rigid 100% amortization. Amortizing the entire loan was implemented following the 1930s’ crash, during which the housing market relied on a single mortgage product: balloon loans. The 15-yr & 30-yr FRM offer a fixed monthly payment which provides certainty of cash flow. For 30-yr loans, payments are lower than short-term loans, making it very attractive for first-time homebuyers who are looking for certainty, but it has a higher rate of interest due to the interest rate risk taken by the investor. The current rate of the 30-yr FRM is at 6.59%, double what it was 1 year ago - 3.12%.
Adjustable Rate Mortgage (ARM) - a home loan with an initial rate that’s fixed for a specified period, then adjusts periodically. The initial interest rate is lower than most FRM loans, giving lower monthly payments at first, and can be locked for one, five, seven or ten years. However, many borrowers fear the potential payment changes and prefer other products. If we look at the 5/1 ARM, which was discontinued last month, we can see it increased by 3.00% YoY - from 2.45% to 5.45%.
Government-backed loan - an effort by the government to assist sectors who might have limited resources, yet deserve some special treatment. Some are designed to help borrowers of more modest means buy a home, others are available only to military service members or veterans. This includes loans guaranteed by the Department of Veterans Affairs (VA loans), FHA-insured loans and loans backed or issued by the Department of Agriculture (USDA loans). If we take the VA loan interest rates for example, the December numbers show the rates more than doubled YoY - from 2.963% to 6.266%. The rates are similar in the other government-backed products.
Jumbo loan - a mortgage above a certain dollar amount. Their limits vary by state and are adjusted periodically. It can have fixed or adjustable rates, requires a credit score of 700 or higher and a down payment of 10% or more. Looking at the current rates, we can see they jumped from 3.201% to 6.58% YoY.
Given everything that we know about the housing market and the conforming human nature, it is no surprise that the 30-yr FRM is so dominant. The longevity reduces the monthly payments and allows borrowers to manage their cash flow. However, there are multiple reasons why this mortgage also has disadvantages. For example, the 100% amortization has an affordability and flexibility downside. Monthly payments of principal repayments are rigid and forced. The American Mortgage, 30-yr FRM, was created for a reason, and has now out served this reason many times over. It was never created to be the mammoth it has become.
What about the other types? Well, ARM is more popular among those who are planning to move in the next 10 years or so, but not many people know that upfront (which is strange, considering the average life-span of a mortgage is well under 10 years). Also, not everyone is a qualified applicant for a government-backed loan (be it FHA or VA), and jumbo loans often have more stringent qualifying criteria.
So we’re back to square one. A 30-yr FRM with a 20% down payment that dominates the mortgage market, leaving many potential homebuyers out of the game and keeping homeownership rate right where it is. That’s not desirable. People are still after the stability of homeownership, but they need a new financing product that competes with agency loans.
It’s time for a change, for a new product that will help us increase homeownership rate in a meaningful way, but more importantly - in a sustainable manner. Preferably a mortgage that has a lower down payment requirement, a lower interest rate, and lower monthly payments that can be either fixed or adjusted, per the borrower’s needs. But for that to happen, the dogma needs to change. Our financial institutions need to start thinking out of the box, and our infrastructure needs to evolve in order to support other mortgage products.
More on that in ‘Part 3 - The Future’.