In the summer of 2022, there is a lot of speculation in the media that the slowing housing market is an indication that the market is headed for a housing crash. People who recall the subprime mortgage crisis are concerned that the recent spike in home prices followed by a pause signals the bursting of another housing bubble. But is the housing market truly in a bubble?
During a housing market crash, the value of a home decreases. You will find sellers that are eager to reduce their asking prices. Sellers may be more motivated to bargain on price or make concessions to buyers. Due to the crash, there may also be short sales and foreclosures, offering you the opportunity to acquire a deal. Many homebuyers may feel that obtaining a mortgage is too risky.
Recessions are temporary pauses in an otherwise booming economy, but they have an impact on the housing market and interest rates. This break, however, may be an excellent moment to purchase or refinance a property. Discuss with your lender how recessions affect interest rates, how you might reduce your mortgage rate, and how to mitigate your homebuying risk. Now, it's more likely that home prices will not crash, and will continue to rise, although at a slower pace.
There is a lower likelihood that a borrower would default on a mortgage. New laws and lessons learned from the 2008 financial crisis have resulted in tougher lending criteria in today's housing market compared to the previous one. Mortgage approval rates today are lower than they were in the pre-crisis era, which suggests that borrowers are less likely to default on their loans. Before the previous housing crash, it was popular for lenders to issue so-called “no-doc loans,” which did not require borrowers to submit proof of their income.
A minimum credit score and a minimum down payment are often required for government-backed loans. According to regulations, lenders must now check a borrower's capacity to repay the loan, among other conditions. Lending standards have tightened and new mortgage credit scores are substantially higher on average now than they were in the early 2000s.
It is also important to keep in mind that a recession will not have a significant impact on home prices if the supply and demand for housing fall at about the same time. Interest rates are one factor that may make a difference. Reduced mortgage rates and consequently lower house costs can bring properties that were previously out of reach within reach. You stand a better chance of your application being approved if you've got good credit.
What Happens to Interest Rates if the Housing Market Crashes?
In a recession, people do not spend, money does not move freely across the economy. They decide against spending and instead save for a better price the next day. Or they save money and do not spend it because they believe they should have precautionary savings. This is true for any industry, including real estate or the housing market.
The Federal Reserve may alter interest rates soon in an effort to minimize economic damage. Occasionally, this helps stabilize markets and boost consumer confidence, resulting in increased expenditure. The adjusted interest rate is used by lenders to determine their interest rates for loans and mortgages in any way possible.
Loans aren't in high demand during a recession since individuals are reluctant to spend money and want to preserve it. Mortgages come in a variety of forms, and each has its advantages and disadvantages, regardless of the economic climate. It's up to you to decide how much risk you're willing to take, but your lender may provide guidance.
The Great Recession left an everlasting imprint on future housing markets. During that period of economic downturn, a greater number of homeowners had mortgages that were upside-down, which means that they owed more on their property than it was worth. As a result of the turmoil that was caused by unemployment and the high levels of consumer debt, lenders were obliged to evaluate in a more strict manner.
The graph below depicts the average 30-year fixed-rate mortgage based on Freddie Mac data obtained from FRED at the Federal Reserve Bank of St. Louis. The shaded areas represent U.S. recessions. The most recent recession, which ran from February to April of 2020, was the COVID-19 pandemic.
Freddie Mac's weekly survey indicates that during this brief period, the 30-year fixed mortgage rate declined from 3.45 percent to 3.23 percent. Thereafter, rates continued to decline, reaching record lows in January 2021. Throughout the Great Recession, which lasted from December 2007 to June 2009, 30-year fixed mortgage rates fluctuated between 6.10 and 5.42 percent.
The Great Recession was sparked by the mortgage crisis, which led the global financial system to collapse. From March 2001 to November 2001, during the early 2000s recession, mortgage rates decreased from 6.95 percent to 6.66 percent. From July 1990 to March 1991, during the recession of the early 1990s, mortgage rates declined from around 10 percent to 9.5 percent.
In the early 1990s recession, which was from July 1981 to November 1982, interest rates fell from 16.83 percent to 13.82 percent. From January 1980 to July 1980, rates decreased rather slowly, from 12.88 percent to 12.19 percent. In every instance, mortgage rates decreased during a recession. Obviously, the reduction varied from as little as 0.22 percent to as much as around 3 percent.
The lone exception was the 1973-1975 recession, which was caused by the 1973 oil crisis and saw rates rise from 8.58 to 8.89 percent. That was a time of so-called stagflation, which, according to some analysts, is reoccurring but remains to be seen. Homeowners, potential house purchasers, and the mortgage sector will all be hoping for the latter, a large fall in mortgage rates.
Many economists equate the 1980s to the present day, so it's feasible that we'll finally see significant respite. How much farther will mortgage rates rise before a recession, if one occurs at all, is the question. Will the 30-year fixed rate continue to rise to 7 or 8 percent by the end of 2022 or the beginning of 2023, then decrease to 6 percent?
If this is the case, any fall associated with a recession would simply return rates to their current elevated level. In other words, brace for the worst while the Fed does its utmost to combat inflation and hope for a swift recovery. In either case, you may wish to bid farewell to mortgage rates between 3 and 4 percent, at least for the foreseeable future.
What Happens to My Mortgage if the Housing Market Crashes?
The 2008 housing crash imposed an enormous financial burden on US households. As house prices fell by 30 percent nationwide, roughly 1 in 4 homeowners was pushed underwater, eventually leading to 7 million foreclosures. After a housing bubble burst, property values in the United States plunged, precipitating a mortgage crisis. Between 2007 and 2010, the United States subprime mortgage crisis was a transnational financial crisis that led to the 2007–2008 global financial crisis.
It was precipitated by a sharp decrease in US house values following the bursting of a housing bubble, which resulted in mortgage delinquencies, foreclosures, and the depreciation of housing-related assets. The Great Recession was preceded by declines in home investment, which were followed by declines in consumer expenditure and subsequently business investment. In regions with a mix of high family debt and higher property price decreases, spending cuts were more pronounced.
The housing bubble that preceded the crisis was financed with mortgage-backed securities (MBSes) and collateralized debt obligations (CDOs), which initially provided higher interest rates (i.e., greater returns) than government securities as well as favorable risk ratings from rating agencies. Several large financial institutions collapsed in September 2008, resulting in a huge interruption in the supply of credit to businesses and individuals, as well as the commencement of a severe worldwide recession.
When property values in the United States fell precipitously after peaking in mid-2006, it became more difficult for borrowers to restructure their loans. Mortgage delinquencies skyrocketed as adjustable-rate mortgages began to reset at higher interest rates (resulting in higher monthly payments). Securities backed by mortgages, notably subprime mortgages, were extensively owned by financial firms throughout the world and lost the majority of their value.
Global investors also curtailed their purchases of mortgage-backed debt and other assets as the private financial system's ability and willingness to support lending declined. Concerns over the health of US credit and financial markets led to credit tightening globally and a slowing of economic development in the US and Europe.
Here's Why This Housing Slowdown Is Unlike Any Other
There aren’t as many risky loans or mortgage delinquencies, although high home prices are forcing many people out of the market. But if the Great Recession was triggered by a 2007-08 housing market crash, is today's market in a similar predicament? No, that's the simplest response. Today, the housing market in the United States is in much better shape. This is in part due to the stricter lending laws that were implemented as a result of the financial crisis. With these new guidelines, today's borrowers are in a far better position.
The average borrower's FICO credit score is a record high 751 for the 53.5 million first-lien home mortgages in the United States today. In 2010, it was 699, two years after the collapse of the banking industry. Considerably this is reflected in the credit quality as lenders have become much more rigorous about lending. As a result of pandemic-fueled demand, home prices have risen over the previous two years. Now homeowners have historic levels of equity in their homes.
According to Black Knight, a provider of mortgage technology and analytics, the so-called tappable equity, which is the amount of cash a borrower may withdraw from their house while still leaving 20% equity on paper, set a new high of $11 trillion this year. That's a 34% rise over the same period last year. Leverage, or the ratio of a homeowner's debt to the value of his or her house, has declined precipitously at the same time.
This is the lowest level of mortgage debt in US history, at less than 43 percent of home prices. When a borrower has more debt than the value of their house, they have negative equity. When compared to 2011, when over one-fourth of all borrowers were underwater, this is an improvement. Only 2.5% of borrowers have equity in their houses less than 10%. If property values do decline, this will give a significant amount of protection.
Just 3 percent of mortgages are past due, which is a record low for mortgage delinquencies. There are still fewer past-due mortgages now than before the epidemic, despite the dramatic rise in delinquencies during the first year. There are still 645,000 borrowers in mortgage forbearance programs connected to the pandemic that has helped millions of people recover.
Even though the pandemic-related forbearance programs have been exhausted by some 300,000 debtors, they are still overdue. Even though mortgage delinquencies are still at historically low levels, recent loan originations have seen a rise in the number of defaults.
The most pressing issue in the housing market right now is home affordability, which is at an all-time low in most regions. While inventory is increasing, it is still less than half of what it was before the pandemic. Rising inventory may ultimately chill house price rise, but the double-digit rate has shown to be extremely resilient thus far. As rising home costs begin to strain some buyers' finances, those who remain in the market should expect less competitive circumstances later in the year.
Home Values May Decline Regardless of a Recession
The housing market is based on a supply and demand cycle. A buyer's market exists when there is a big inventory of properties for sale, and property prices tend to decline. When inventory is low, however, residences are in high demand and the market shifts to a seller's market. It takes time to develop new dwellings and replenish supplies.
Housing prices will begin to fall if inventory grows and demand is fulfilled. Another reason that property prices have lately slowed is that individuals can no longer afford them. Income levels have not kept pace with house costs, and many first-time buyers who are still saddled with college loans cannot afford the extra weight of a mortgage.
The current housing inflation storm is driving buyers out of the market, contributing to the protracted period of extremely limited inventory—but sellers are still hesitant to lower prices. Waiting may be the best option for purchasers with time, regardless of whether there is a recession. According to Realtor.com, the number of houses for sale increased by the most in June 2022 on record. Active listings increased 18.7 percent year on year, but property prices remain persistently high.
In June, the national median listing price for active properties increased 16.9 percent from the previous month to $450,000. So far, property prices are up 31.4 percent from June 2020. It may take some time for values to fall because sellers are still trying to obtain top money for their property. Sellers are attempting to price their houses in line with recent comparables that closed in 2021—when mortgage rates were still at record lows and inventory was scarce.
However, many purchasers are waiting to see what happens in the autumn housing market, when there will be more inventory as well as greater competition. There is a lack of consensus on whether or not now is a good moment to purchase a house. In contrast to the most recent housing crash, which occurred during the financial crisis of 2008, we are currently experiencing growing inflation while job levels continue to be solid. The majority of economists were surprised by how quickly jobs were added in June.
The jobs market has been seen as the bulwark against a recession, and June’s numbers show that the employment pillar remains strong. Job growth accelerated at a much faster pace than expected in June, indicating that the main pillar of the U.S. economy remains strong despite pockets of weakness. Nonfarm payrolls increased 372,000 in the month, better than the 250,000 Dow Jones estimate and continuing what has been a strong year for job growth, according to data from the Bureau of Labor Statistics.
“The strong 372,000 gain in non-farm payrolls in June appears to make a mockery of claims the economy is heading into, let alone already in, a recession,” said Andrew Hunter, senior U.S. economist at Capital Economics.
The years that you anticipate living in the house is another factor that might play a role in determining whether or not you should buy it right away. Those who do not intend to remain in the house for at least five years after the purchase may end up losing money if the housing market experiences a crash after the purchase and they decide to sell. On the other side, attempting to time the market incorrectly might result in you missing out on the opportunity to purchase your ideal house.
You may be priced out of the market if interest rates continue to climb and home prices do not fall by an amount that is sufficient to compensate for high mortgage expenses. Buyers are in a better position to take advantage of the increasing availability of houses now that sellers are asking for more reasonable prices for their properties. If there is a downturn in the economy, mortgage interest rates will very certainly fall to about 4 percent or even lower. If it does, it could be a good time to hold off and save some money, especially for first-time homeowners.