Mortgage Daily

Published On: June 15, 2007
Housing Outlook

Study from Harvard

June 15, 2007


photo of Coco Salazar
While economists remain upbeat about the long-term outlook of the residential real estate market, the near term is tainted by the uncertainty of future performance on loans set to readjust amid a struggling housing market.

The housing market continues to struggle under sharp drops in housing demand and oversupply of homes, and housing starts and sales are on track to end this year even lower through a fallout of both mortgage borrowers and investors, according to the 2007 State of Nation’s Housing report by the Harvard University Joint Center for Housing Studies.

“The air went out of the inflated housing market as higher home prices and interest rates finally tempered demand,” said Nicolas P. Retsinas, a director of the Joint Center for Housing Studies, in an announcement. “Many buyers are now waiting on the sidelines hoping prices will fall.

The tightening of credit standards amid worse-than-anticipated subprime loan performance is further dampening demand. Between the fourth quarter 2005 and the fourth quarter 2006, the share of troubled subprime loans jumped from 6.6 percent to 7.9 percent.

Subprime loans and “affordability products,”those with interest-only and payment option features, have gone from relative obscurity to large shares of the market.

IO loans and payment-option mortgages reportedly went from accounting for less than 5 percent of originations in early 2002 to 38 percent in mid-2005, before falling back to 32 percent at yearend 2006.s

Subprime lending surged to account for over 20 percent of originations last year from nearly 9 percent in 2001 and almost zero in the early 1990s. The share of Alt-A loans jumped to more than 13 percent of originations last year from about 3 percent five years earlier, the center reported. Additionally, large shares of 2004 subprime and Alt-A originations have adjustable rates that are scheduled to reset between two and five years after origination, resulting in potentially significant increases in monthly payments.

“In the absence of rapid house price appreciation, the risks imposed by subprime adjustable-rate products are much greater,” the report stated. “As the first wave of these loans begins to reach their reset dates, the signs are not encouraging.”

The amount of subprime ARM and Alt-A debt expected to reset in 2007 and 2008 could be as much as $540 billion. Alt-A resets will account for about $57 billion of that total, and $85 billion in 2009 and 2010.

While much of this debt is likely to be either refinanced or paid off at the time of sale before the reset dates hit, “it is unclear how the wave of subprime loans with steep initial discounts” will perform when adjusted to higher interest rates, the report states.

“Already, homes entering foreclosure increased by about 75,000 from the fourth quarter of 2005 to the fourth quarter of 2006,” the report continued. “Until some of the excess inventory is absorbed by the demand cycle and credit conditions stabilize, housing will continue to struggle and home prices will fall in more areas.”

Across all loans, nearly 250,000 homeowners entered foreclosure proceedings during the fourth quarter 2006, up 100,000 from mid-2005, the center reported

The nation’s largest housing challenge reportedly continues to be housing affordability. Starting in 2003, total household debt exceeded total personal income and the share of home mortgage debt continues growing — increasing to 73 percent last year from 65 percent in 2000.

“In just one year the number of households spending more than half their income on housing increased a startling 1.2 million to 17 million in 2005,” said Rachel Drew, a research analyst, in an announcement. “Even if prices or rents soften for a period of time, the nature of US labor markets, the regulatory restrictions imposed on residential development, and the fiscal limits of government assistance to cost-burdened households will make affordability a long-term challenge.”

Some borrowers have tried to escape such cost burdens by taking longer commutes and incurring higher travel costs, while others share housing or live in undesirable neighborhoods.

Weak income growth among households in the bottom half of the distribution, together with restrictive land use regulations, has led to the implacable spread of affordability problems,” the report stated. “With little regulatory relief in sight and slim chances for a significant expansion of federal subsidies, the prospects for a meaningful reduction in the number of housing cost-burdened households are dismal.”

“While it will take time to work out current loan problems and work off the oversupply of homes, the long-term outlook for residential investment remains strong,” the Joint Center said in the announcement. Largely, as a result of a record number of new immigrants arriving in the United States in the 1990s and larger numbers entering this decade, net household growth is poised to accelerate by about 2 million to 14.6 million households 2005-2015.

“In addition, incomes and wealth stand higher for most households in real terms than ten years ago. This should translate into solid growth in both new construction and remodeling spending over the next ten years compared with the last ten.”

“But the longer-term outlook for housing is more upbeat,” according to the report. “Thanks in large part to recent immigrants and their native-born children, household growth between 2005 and 2015 should exceed the strong 12.6 million net increase in 1995–2005 by some 2.0 million. Together with the enormous increase in household wealth over the past 20 years, healthy income growth will help propel residential spending to new heights.”

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