Residential Magazine

Teetering on a Cliff

Borrowers could be in for a shock if the housing market takes a tumble

By Christopher Hussain

Homeowners who purchased their first home in 2012 or later have consistently experienced rising property values and relatively low interest rates. This has allowed many of them to upgrade to larger homes, or refinance to consolidate and lower payments, affording them the psychological comfort of growing personal net worth.

Many of these people have never seen their home value drop significantly and have never managed their finances without the safety net of a mortgage refinance as an option. This may soon change.
Easy monetary policy and government spending have driven real estate prices ever higher since 2012, when the U.S. economy fully turned the corner after the 2008 housing crisis. The reversal of these conditions will have a profound psychological effect on homebuyers that could materially impact the businesses of mortgage lenders, originators and servicers.
Homeowners may sell their properties if they worry that prices are going to plummet. Potential homebuyers may give up on the market if rising interest rates increase their current loan-to-value ratios, disqualifying them from affording their dream home. Savvy mortgage lenders and originators should understand how existing homeowners and prospective borrowers could react in an unfavorable housing climate.

Bearish signals

Conditions are in place for a correction in residential real estate prices nationwide. Federal Reserve chair Jerome Powell signaled in congressional testimony that the central bank is focused on controlling inflation, which means an end to quantitative easing and higher overnight lending rates. As a result, mortgage rates will rise and home-price growth will slow or decline.
The smart money knows this and is preparing for the first serious housing-market decline since prices bottomed in fourth-quarter 2012. This past October, Zillow announced that it would close its iBuyer program, known as Zillow Offers, where the company bought, renovated and resold homes.
The online real estate giant explained this as a move to “enable Zillow Offers to focus operations on purchasing homes with already-signed contracts, but have yet to close, and reduce the renovation pipeline.” Essentially, Zillow told the market that the company wants to reduce its inventory. As a large and well-informed institutional investor in residential properties, unloading real estate is a bearish signal.
It remains to be seen if other iBuyers such as Redfin, Opendoor and Homesnap will follow Zillow’s lead. Redfin reported in August 2021 that competition for home-purchase offers had plummeted. Nonbank mortgage lenders, seeing the correction on the way, are starting to streamline for leaner times. Interfirst Mortgage announced more than 350 layoffs in November 2021. cut 900 workers in a now infamous Zoom call in December 2021, followed by 3,000 more in March 2022.
Mortgage originators shouldn’t think their offices are safe just because they aren’t running call-center models that are known for hiring inexperienced staff. Corporate offices will be quick to cut nonproducers who may be experienced but only do loans as a side gig to their more stable full-time jobs. Winter is here and layoffs are coming.
The S&P CoreLogic Case-Shiller Index reported late last year that home-price growth peaked during the summer and is now decelerating. Redfin projected that home-price growth would slow to 3% year over year by December 2022. Additionally, the Mortgage Bankers Association (MBA) forecast this past November that home prices would drop 2.5% year over year in 2022. In more recent forecasts, the MBA has predicted price increases throughout this year, but this underscores the potential volatility. These numbers may represent hope over science.

Economic fundamentals

Americans have been sold on a story of never-ending home-price appreciation and low-cost financing. Residential real estate has taken on characteristics of “meme stocks” such as theater chain AMC Entertainment and video game retailer GameStop. Throughout 2021, the price of these stocks inflated and deflated based on internet chatter and coordinated buying efforts. Eventually, fundamentals will take hold and drive valuations down from lofty, pumped-up levels.
Home prices are far less volatile than stock prices since homes are sold less frequently than stocks are traded. But as with stocks, prices are determined by economic conditions and the quality of the asset, not by a narrative of a never-ending bull market.
People’s tendency to chase trends is one of the fundamental fallacies identified by behavioral economists. When people experience a long-term trend, such as 10 years of home-price appreciation with little to no volatility, they imagine these conditions will last forever. As was the case before the Great Recession, amateur investors with no real experience have jumped on the gravy train and have started flipping homes — usually the sign of a bubble.
Homebuyers who closed their transactions in 2012 or later bought under the Goldilocks principle — when the right conditions occur at the right time to trigger a fundamental change. In this case, mortgage rates were low and homes were cheap, lead-ing to a market boom aided by Fed policies put in place specifically to inflate asset prices.
A real estate buyer today can still get a relatively low mortgage rate and might be told that they can buy “more house,” but the price of the house is bound to be elevated. A great mortgage on an overpriced home does not add up to a good deal.
Indeed, the ease to obtain financing combined with persistently high rent prices may entice some consumers to make larger purchases at a perilous moment. It also will be hard for buyers to notice that the correction is happening. Home and stock prices won’t suddenly fall when the Fed begins raising interest rates. The process will play out over months while unwary homebuyers will continue to take on inventory at inflated prices.

Slow recovery

Mortgage originators and servicers should prepare for a correction, followed by a slow recovery, as people shocked by their first bear market will be wary to return to the housing market. One way to protect your business is to invest in cost-saving technologies that allow for faster speed to market and more efficient operations during a prolonged lean period. Clients will mainly fall into three categories: those who plan, those who panic and those who hold on for dear life.
Planners see the conditions for a correction in place and are making moves now. They’re taking advantage of a last chance to refinance or accelerate plans to sell their home for a good price, possibly to downgrade or to rent during the downturn. They’re also considering selling any unnecessary second homes or investment properties. The planners, in this sense, will be part of the wave of selling that could spark a correction. Those who act early will have the best results.
This group knows that the risk-free rate of return offered by savings accounts and certificate of deposit accounts will provide a haven and a buffer against stock and real estate corrections. Often, the value of a home can preserve wealth during corrections, but this downturn is poised to hammer stocks and real estate in tandem. Planners will aim to maximize profits by increasing liquidity.
Panickers will sell into a declining market. Short on cash while seeing the value of their homes and stocks fall simultaneously, and unable to refinance at favorable terms, they will sell their homes for less than they had hoped. Those who bought their homes late in the cycle might have to sell at a loss, which will diminish their purchasing power heading into the recovery. In a worst-case scenario, they may lose their jobs if a recession hits.
These homeowners will look to the Fed and the government for help. This is not like the downturn associated with the COVID-19 pandemic, however. The Fed and Treasury will be cooling the economy on purpose to tame inflation and won’t come to the rescue. Already, the government is allowing pandemic-era stimulus measures (such as the student loan moratorium and advanced child tax-credit payments) to end.
The last group — people who hold on for dear life — have been propping up the market while enjoying the positive wealth effects of a bull market. Many workers in their mid-20s to late 40s have only experienced increasing wages, growth in their investments and decreases to borrowing costs. They have been taught that markets are cyclical and to hold on to all investments.
The typical argument is that downturns are temporary and that asset prices will rise again after a recession. These people may have to wait longer than they think. When housing prices began to contract in 2007, residential real estate remained in a bear market for five years.
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Economic conditions are far better now than they were during the financial crisis of the late 2000s. The next downturn should not be as long or as severe, but a sudden reversal in housing fortunes is bound to have a lasting and negative effect on the entire mortgage industry. The best time to prepare is now. ●


  • Christopher Hussain

    Christopher Hussain is CEO of RealKey, a mortgage submission platform that he founded in 2015. A born entrepreneur, in 2013 he also co-founded Sindeo, a San Francisco-based startup that raised $50 million to create a new mortgage experience. As a recognized business and thought leader in the industry, he has successfully scaled numerous mortgage companies. In his current role at RealKey, Hussain is leveraging his breadth of industry experience to transform and enable faster, more efficient mortgage processing.

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