Solutions to Housing Market Woes are Hiding in Plain Sight
There's never a dull moment on the residential real estate scene. From bubbles to downturns to housing shortages - and so on - being a prospective homebuyer or seller is not for the faint of heart.
So how will America solve the residential supply logjam created by past underbuilding, recent super low mortgage rates, and today’s increasing high cost of mortgages? That is the question.
Shortage Magnified
Currently, the Federal Reserve’s ongoing battle against inflation using ever-increasing interest rates has intensified the shortage of available houses as existing homeowners have tightened their grip on those mortgages with rates just above…and yeah, some below… 3%. Unless forced to move because of job opportunities or other unavoidable circumstances, current owners are very reluctant to take on new loans at rates above 7%, particularly since home prices in many locations remain strong due to low inventories.
An example: Based on a conventional 30-year, 7% fixed-rate loan on a median priced home (in the $340,000 range), a borrower might pay an additional $700 or so per month than he/she/they would have done in the 2020 era of 3% mortgage rates. Not many folks with 3% mortgages are willing to make that trade.
Is there a solution to the conundrum that has sucked both supply and demand out of the housing market – particularly if the Fed keeps rates high well beyond 2023? Are there ways to loosen supply a bit, helping prospective buyers land a home?
There are several intriguing possibilities that could help prospective buyers avoid taking on higher interest rates and sellers negotiate higher prices for their homes - and they're hiding in plain sight.
At the top of the list: Assumable Loans
Assumable Loans
Among the millions of outstanding mortgages with that enviable 3% rate, some are what's called “assumable loans.” This designation allows the homeowner to transfer their house and the low rate loan to the buyer. Approximately 20% of mortgages – including loans available through the FHA and VA programs – are part of the government programs that have assumption features, according to Black Knight, a mortgage-data and technology company.
Typically, lenders are not big on the idea (more work and less money) and curiously, very few prospective borrowers are familiar with this assumption option.
How They Differ
A standard residential sale involves a home buyer who takes on a mortgage at the going market rate to pay for the purchase.The seller uses the proceeds of the buyer’s loan to pay off the balance of his mortgage and keeps any surplus.
In the case of an assumable loan, the seller's existing mortgage is not replaced by a new one. Instead, it transfers to the new owner; thus, relieving the seller of the mortgage liability if certain rules are followed. Of course, if the selling price of the home exceeds the assumed mortgage liability, the buyer must produce the cash to cover the balance of the purchase price – or most likely by incurring a second loan at the going market rate.
Assumable Challenges
As mentioned earlier, lenders are not monetarily inspired to move very quickly when processing assumable loans because they earn very little doing so….far less than they make originating new loans. If assumptions do become more widely known as a means of breaking the logjam in residential real estate, it is probable that mortgage investors will demand higher rates on new loans as compensation for having to hold those low-interest assumable mortgages for longer periods.
NOTE: VA loan holders might think twice before transferring their assumable mortgages to non-entitled loan holders because they can obviate their ability to qualify for a new VA loan immediately. To clarify, in order for an original VA loan to be issued, that borrower must have a VA loan entitlement. Here's how that works:
If the new borrower has his or her own VA loan entitlement, the seller can - and most likely will - ask the new buyer to officially substitute the entitlements.
Should the new borrower not have adequate entitlement to make the substitution, then the seller’s entitlement will remain attached to the home until the loan is paid off.
In short, if a seller doesn’t confirm whether the borrower has sufficient entitlements for a substitution, his or her VA loan entitlement will remain attached to the home, preventing him or her from using it elsewhere until the assumed loan is paid off.
Creative Catalysts
Fed rate increases might be nearing an end, but how long will they remain at current high levels? Affordability will likely be the major challenge for some time to come.
The housing shortage will not be solved by the construction of spacious homes with big backyards because mid- and lower-priced affordable housing is where the major shortage is. Here are more possible solutions to the residential sales logjam:
The conversion of unused malls and office buildings to residential could help resolve both the residential supply problem and commercial real estate's lagging demand conundrum.
Placing more restrictive limits on single family zoning would help encourage the construction of "missing middle" housing, like townhouses, duplexes and triplexes.
There is ample opportunity to encourage existing homeowners to develop “accessory dwelling units” in their own abodes for aging Baby Boomer parents, adult children, and third-party renters. Garage apartments, bungalows, granny flats, and in-law suites not only could provide free or affordable small living quarters, but could also serve as potential sources of income for owners - or savings for family members seeking to accumulate down payments for future home purchases.
With proper incentive, builders might be enticed to construct more manufactured or trailer homes in response to mortgage giants Fannie Mae and Freddie Mac backing mortgages on higher-end prefab homes, thus adding important supply to the inventory mix.
Developers could aggressively pursue the growing demand for “micro-unit” apartments by entry level or lower income buyers who find the old American dream of a big house with a yard out of reach.
These solutions may serve as short term catalysts for breaking the logjam and provide hope that the limited inventory of affordable homes will be resolved.
The reality is - no matter the state of the market, people will continue to buy homes. In today’s market, it’s simply a question of what type of living quarters they can afford to buy.