By: Sean Gallagher CFP®
The US Financial Crisis of 2008 serves as one of the most memorable and devastating financial downturns in history. Regardless of your age, financial status, or area of living, the crisis likely had some impact on your life at the time.
While many remember the crash in the stock market and the ensuing global recession, it’s essential to examine the underlying aspects of the real estate market which led to the build-up.
Fifteen years removed from the peak of the housing bubble, is the real estate market different now than it was back then?
1. Mortgage Loan Approvals
Appropriately named the “Subprime Mortgage Crisis,” an initial factor of the collapse involved generous mortgage loan approvals. A subprime mortgage is a mortgage targeted at borrowers with less-than-perfect credit and less-than-adequate savings. As you might expect, these subprime borrowers are at a much higher risk of defaulting on their loans.
Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in response to this dangerous mortgage approval practice. One of the primary features of the Dodd-Frank act was to curb predatory behavior from mortgage companies and raise standard lending requirements for borrowers. This mission would prevent risky consumers from obtaining loans that could ultimately be harmful to their financial health.
Today, lenders have raised standards even beyond the requirements of Dodd-Frank. Loans are now smaller in proportion to home values and borrowers’ income.
According to Federal Reserve Economic Data (FRED), the average proportion of US personal income towards mortgage payments is 3.4% in 2021, down from 7.2% leading up to the housing crisis. Borrowers’ average credit scores are also higher, and they can no longer obtain a mortgage without showing documentation of their creditworthiness.
2. Mortgage Rates
Adjustable-rate mortgages start with a fixed and typically low-interest rate for a set period, then adjust yearly or monthly. During the adjustable period, these rates can increase and cause the monthly mortgage payment to grow. Only about 0.1% of mortgage loans issued this year carry flexible rates, compared to about 60% in the bubble years. These adjustable-rate mortgages were a significant oversight for many borrowers who anticipated affordable monthly payments.
Once risky borrowers could obtain high-risk loans, they eventually fell behind on their mortgage payments due to high fixed rates and increases in the adjustable rates—a higher mortgage interest rate translates to a higher monthly payment for borrowers.
In 2006, the average 30-year fixed-rate mortgage was 6.41%. As of October 1st, 2021, that rate has dropped to 3.01%. While rates are expected to rise in the future steadily, this is still a considerable difference in rate environments from 15 years ago.
3. Housing Equity
In 2006, the risky lending practices led to subprime borrowers beginning to default on their mortgage payments. Logically, someone who can’t afford to pay for their current home would look to sell it and find somewhere else to live. As this selling became more rapid, housing prices began to drop drastically. Eventually, homeowners’ equity began to turn negative as their mortgages were worth more than the existing house values.
Negative equity makes a home virtually impossible to sell, considering the buyer needs to cover the home value price and the outstanding loan above the home value. Suppose the buyer is unwilling to pay above market value for the home. In that case, the seller must cover the remaining liability or negotiate with the mortgage company to write off the loss on the loan. According to data from CoreLogic Inc., in late 2009, 26% of homeowners had negative equity. Today, that number is only 2.8%.
Summary
The US real estate market has learned from its mistakes of 15 years ago and is in a much more secure place today.
Loans are much harder to get now compared to 2006.
Mortgage rates are both lower and more stable due to fewer adjustable-rate mortgages.
Housing equity is much higher today and nowhere near the negative equity rates that followed the crisis.
Currently, there is little concern that the real estate market will repeat its downfall from 2006. The S&P CoreLogic Case-Shiller Index, an index measuring the average home prices in major metropolitan areas across the US, set another record in July by increasing 19.70% year over year. As the data comes in and the index continues to develop record increases for consecutive months, we will continue to monitor the real estate market for potential red flags.
Sean Gallagher is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Sean graduated from Virginia Tech’s financial planning program in 2018 and successfully passed the CFP® national exam in 2019. As a Financial Planner at HIGHLAND Financial Advisors, Sean works on developing comprehensive financial plans and investment management for all clients.