In simplest words, the housing market is such a market under which the supply and demand of real estate in a particular region, locality or nation is determined. There are a number of other concepts related to the housing market that need to be understood in order to have a full grasp over the subject. For instance; the Home Information Packs (HIPs), which comprise of the information and facts about the house price sale; the House Price Inflation, which is the yearly increase in the house prices for the past year; Affordable Housing, which comes under the market that deals with first time buyers and core public segment workers and their budget.
Alternative ways of financing Housing Purchases
When one is seeking to raise finance, especially for housing purchases, there are a couple of alternatives that could be considered. For example:
Agreed Overdraft
Unlike the unauthorised overdrafts which are quite expensive, agreed overdraft, a type of unsecured loan, is often likely to be a very economical means for borrowing money. Using an agreed overdraft, one comes to an agreement with their bank manager over a certain limit on how much they can go in-debt with their required payments. Interest is paid only on the amount one is in the red and not the decided limit. Therefore, if one’s resources go up and down a great deal, at times this can work out reasonably and quite economically as compared to the normal loan.
Shared Ownership
A very conventional method, shared ownership is, used in house purchases. By means of this method, one is not mounting up as much debt because they don’t have to pay for the entire worth of the asset, but merely their own share. For availing the benefit of this method, Housing Association Schemes are present. Also known as equity-sharing schemes, such programs are drawn up to assist first time buyers make an entrance into the housing markets, or make it possible for someone to buy a house that they could not have the funds for otherwise.
For example, when a person pays for a percentage share of the house, it is on the housing association to pay for the rest. This way, the person has the sole right to use and live in the house. However, when it is the time for selling, the earnings are to be shared with the housing association under the same ratio as it was when purchasing. Therefore one incurs much less debt, by using a shared ownership scheme, than they would have otherwise. (Finance Alternatives, 1995)
Lease/Purchase Housing
This is a devised scheme for homeownership that stretches the arena of likely homeowners, which works to bring in both lower income parties and individuals and households with feeble credit with scarce or no savings at all. Using this scheme, a company acquires and leases a home to a household that is unable to attain a mortgage due to low income or poor credit reasons. It then assists the household to rise above all obstacles to a final purchase. The span of time for the home leasing usually depends on the time required by an individual or family, to accumulate funds for down payment or to settle certain credit matters.
Under this lease/purchase housing program, the dangerous possibility of default is shifted from the mortgagee to the subsidizing company in the course of the lease episode. If that particular company does not have a leasing property administration understanding, practice, and proper funds to assist some residents across thin times, this lease/purchase scheme can correspond to a high risk. Therefore, most lease/purchase lenders keep a tight rein on the number of units a company can build up at one time, which is generally on the basis of funds or the company’s financial residues. (The Enterprise Foundation, 2003)
Prime and Subprime Mortgages
Holding quite an importance under the housing market subject – borrowers who have lower credit risks as revealed by their past ability to meet all their due debts, to keep a good credit rating score (e.g. the Fair, Isaac, and Company score), plus the capacity to make a sufficient down payment, are charged prime mortgage rates by lenders. The lenders who charge this prevailing rate are known as prime lenders. On the other hand, there are high-risk borrowers who do not have a fair past record in terms of debt-payments. These individuals are offered with sub-prime mortgages, the lenders known as subprime lenders.
Hence, the major difference between prime and subprime mortgages rests in the possibility of the borrower presenting a risky profile. Loan risk grades of the mortgage applicants are assessed by the lenders, generally on the basis of their possible mortgage or rent payment history, debt-to-income ratios, past bankruptcy filings, and the degree of income verification documents provided by the candidate. The borrower’s credit risk score is also used as a tool to ascertain the mortgage price. (Agarwal, 2007)
Regarding the stock of mortgages outstanding from 2006, as stated by the Mortgage Bankers Association; of the mortgage market, prime mortgages constitute about 80%, subprime mortgages about 15%, and the rest by other loans.
It was in early 1990s when the subprime mortgages increased in popularity. This was because of the falling interest rates that made them attractive to home-owners, to put money again into the standing mortgages, establish debt, or fund for home enhancement. Such spreading out of the subprime mortgage market has made those households able to achieve home-ownership, who would not have been able to in the past. The minority and low-income public is the one at a broad based gain in terms of home-ownership. But these subprime borrowers who hold low credit scores and have weak financial conditions lead to a greater cost of borrowing. In addition to this, declining house prices and up surging interest rates has put a rising pressure on delinquency (overdue debt) rates for the subprime borrowers.
Other methods of Credit Rating of borrowers
A couple of measures are used to rate the credit position of borrowers, identifying the very level of it being the first step. In the housing sector, lenders always look for a reliable measure of credit position, as vital for prepayment forecast. However, due to the lack of suitable financing criteria for each credit title among issuers, the development of a uniform assessment of a borrower’s credit condition may be difficult. Thus in order to solve this problem, a database is established in which loans are indexed. First this is done by means of the credit title, which the issuers have supplied, and secondly the ‘credit premium’ is measured, which the borrower has paid at origination.
It has been ascertained that the credit history criterion applied to a certain credit title were comparatively consistent, even regardless of the differences in financing methods. Thus, instead of rejecting the issuer provided credit rating, this is actually used as a broad sign or hint of a borrower’s latest credit position.
In a set credit class, the loans are further grouped by measuring a credit premium. It is centered on the spread concerning the existing conforming rate, and the mortgage rate on the day each loan was initiated. Even though this method overlooks the probability that a borrower ‘buys’ the rate down, it has verified and sustained to be intensely associated to the genuine credit position of a borrower. If the credit premium is higher, then the credit position of the borrower is said to lower. (Fabozzi & Ramsey pp. 301, 2000)
Securitization of Housing Purchases
Securitization is the pooling of non-liquid loans or assets into marketable securities. It is one of influential tendencies for dramatically changing the backdrop of financial markets. Its usefulness is determined by its capacity to reduce intermediation costs and intensifying risk sharing and risk diversification. (Hess & Smith, 1988) On account of securitization, mortgage assets can easily be converted to cash while mortgage risks are divided among a large party of investors. It lessens the mortgage loan origination fees, which results in extraordinary savings for consumers. (Todd, 2001)
Securitization is generally a good thing, as it enables consumers to have to pay a cheaper price and furthermore provides liquidity essential for home-financing in any capacity. However, the future of securitization of mortgage-debt is dreadfully in disbelief now. According to an article appeared in the Financial Times: “Only $9.9 billion of home equity loan securitizations have come to market since July 1—A 95% decline from the $200.9 billion in the first half of this year and a roughly 92% decrease from the same period last year.” (Whitney, 2007)
Housing Market conditions in the U.S.
After a notable and momentous five-year surge impelled by a strong intense economy with low interest rates, the real estate market smashed in 2006, on the word of the final record publicized by the National Association of Realtors. This week’s statistics on the drooping real estate market places no doubt that the housing flight is rapidly collapsing into the earth and difficult times are on the cards. As the New York Times put it, “The slump in home prices from the end of 2005 to the end of 2006 was the biggest year over year drop since the National Association of Realtors started keeping track in 1982.” According to the Commerce Department, it was in early 2006 that the construction of new homes sunk by 14.3% and by the end of the same year the number of vacant homes increased by 34% to 2.1 million. States like Florida, Arizona, Virginia, and California have experienced an impulsive decline in existing home sales.
The underlying unavoidable factor is that inventories are ahead, sales are low, profits are worn down, and the housing market is drawn against a constant slump into the very much predicted future. The undulation of the housing crash is anticipated to be suffered by the whole economy; declining GDP, sluggish consumer spending, and filling the increasing unemployment lines with more workers.
The banks and mortgagees are struggling and rushing for inspired ways to hold people in their homes, but on the other hand the subprime market is already in a precarious position and foreclosures are getting on their feet. The United States is indeed at the beginning of a radical change and “there’s going to be a lot more blood on the tracks before things settle down.” (Whitney, 2007)
As said by the economists in the recent Wall Street Journal forecasting survey, those seeking out to reprieve from the housing slump should not be optimistic about any recovery before long. The mass of respondents are of the view that the U.S. economy, at present, is in recession, with the housing market sector as the hard long slog. The Office of Federal Housing Enterprise Oversight gauges, and economists notice, around 5.3% decrease in house prices by the end of 2008 and 1.3% drop in 2009.
Below is the recent U.S. house market graph, representing the median prices and the existing sales since the early 1990s.
Focusing on the statistics in four major states of the U.S., the following graphs have been obtained. (Source: House Prices 2008)
US House Price Graph 2004-2011
Now, the issue is, how bad can this get? As the United States has never undergone such a downturn, therefore no one is quite in a position to comment anything. At present most economists expect the U.S. to go through a minor recession in 2008. But nonetheless, there is a probability of a very precipitous decline that the conventional recession cures won’t be capable of handling. (Coy, 2008) Recommendations from the bosses of the Federal Reserve, SEC, and the Commodities Futures Trading Commission, in an assembly report comprise of strong countrywide licensing standards mortgage brokers in addition to stricter state and federal oversight of mortgage lenders. (BBC News, 2008)
References
Agarwal, Sumit (2007), Comparing the Prime and Subprime Markets, Chicago Fed Letter, Number 241. Web.
BBC News (2008), U.S. wants tougher mortgage rules, International Version. Web.
Coy, Peter (2008), Recession Time, Business Week, Cover Story.
Fabozzi, Frank J. & Ramsey, Chuck (2000), Mortgage-backed securities, John Wiley and Sons, Page number: 301.
Finance Alternatives (1995), Other Ways To Raise Finance, Team Technology. Web.
Hess, A.C. and C.W. Smith, Jr. (1988), Elements of Mortgage Securitization, Journal of Real Estate Finance and Economics, 1: 331-346.
The Enterprise Foundation (2003), Alternative Financing Models Hybrids of Homeownership Lease/Purchase Housing, Enterprise Resource Database.
Todd, Steven (2001) The Effects of Securitization on Consumer Mortgage Costs, Real Estate Economics, Volume: 29, Issue: 1, Page Number: 29.
Whitney, Mike (2007), Housing Flameout: California Falls Into The Sea.
Whitney, Mike (2007), U.S. Housing Market Crash to result in the Second Great Depression, The Market Oracle, Economics/ Analysis & Strategy. Web.