The Risk to Follow

Implications: Mortgage defaults and tightening lending standards should be on the minds of those active in the home building industry. Not only are subprime lenders struggling, Alt-A mortgage providers are experiencing higher than expected default rates.

Analysis:

While speculative inventories remain a concern as new home prices continue to fall, mortgage defaults and tightening lending standards should be on the minds of those active in the home building industry. Not only are subprime lenders struggling, so called “Alt-A” mortgage providers are experiencing higher than expected default rates, according to information provided in this Wall Street Journal article.

What does this mean for the housing market? What are the go-forward risks? We believe the risks posed include, further drops in housing prices and thinning of demand / credit qualifying due to tightening credit standards and rate increases.

Further price drops would be caused by lenders seeking to sell off repossessed homes. Rather than sell homes at “market rate” prices, lenders often slash prices below market value, employing a “cut-and-run” strategy. Lenders are not in the business of “owning” homes, they are in the business of originating and managing loans. If enough resale homes were being sold at below market prices, home builders could be forced to cut prices to compete. Of the two risks, further drops in new housing prices and tightening underwriting, this is the lesser risk.

The larger risk is tightening lending standards and rising loan rates. In affordable housing markets, certainly many areas of the Phoenix metro area, tightening underwriting standards would have a negative affect on sales. Entry-level and move-up buyers in these market areas, like Queen Creek, Surprise, and Buckeye, rely heavily upon Alt-A and subprime mortgages to purchase new homes. If underwriting standards tighten, fewer buyers will qualify to purchase homes. Higher prices, too, follow the perception of increasing risk. Loan rates will rise, pricing some buyers out of new homes.

Enter any sales office in most active metro market areas and you will find the number of people buying homes with little or nothing down is high. You will find the number of “credit challenged” buyers is high. And, thus, you will find, maintaining new home sales levels- even current levels- will be difficult with tightening credit standards. Watch the default rate and lending standards because this is the primary threat to the housing market right now.