Housing Market Leveling Out

Several sources indicate that the housing market is flattening. However, it will be important to monitor foreclosures as rates reset.


With ample evidence to support a housing bubble scenario, it now looks like the housing market is beginning to level out and may avoid the drastic fall that many have anticipated.  While the housing market is not as vibrant as it has been over the last few years, there are several indicators that have been recently published to support this forecast.

1. Pending Home Sales Index— The National Association of Realtors (NAR) announced that the Pending Home Sales Index rose 1.3% to 113.4 in May 2006 from 111.9 in April 2006, but it is 10.1% below May 2005.  The Index is calculated by monitoring pending sales of existing homes for which the contract has been signed but the transaction has not yet closed.  An index score of 100 signifies the average level of contract activity in 2001 when the NAR started tracking the measure.  With the Index increasing in May and not falling rapidly over the past 12 months, it signifies that the housing market is settling down from the exuberance of recent years. 

2. Price-Rent Index— The house price-to-rent ratio increased to 1.50 as of the first quarter of 2006, its highest level since the ratio has been calculated.  Although national numbers for the second quarter are not yet available, markets such as Washington, D.C. where rents have risen 7% in the past year according to Delta Associates, may indicate that rental prices are finally beginning to catch up. 

3. Pricing out Potential Borrowers—The National Association of Home Builders and Broker Watchdog recently studied the effects of rising mortgage rates on potential borrowers’ abilities to afford a median-priced home ($224,400 in 2005 according to the Census Bureau).  The study found that as mortgage rates rise, fewer people can afford the purchase.  Specifically, as mortgage rates rise in 25 basis point intervals up to 6.50%, 1.2 million people are priced out each time.  Above 6.50%, a smaller number of households are priced out following every increase as there are fewer households in the upper income levels of the United States.   

The average 30-year fixed rate mortgage was 6.82% and a one-year adjustable rate mortgage (ARM) was 6.47% as of July 28, 2006, according to HSH Associates.  Given the current mortgage rates, a large percentage of American households are already priced out of purchasing the median-priced home.  If mortgage rates continue to rise, fewer households will be able to afford the prevailing house prices, causing prices to flatten.

4. Prices Lag Sales Volume— In the second quarterly report of 2006, the UCLA Anderson Forecast predicts that real estate will slow down but will not cause a national recession.  Director Edward Leamer stated in the report that house price fluctuations typically lag sales volume levels, meaning that even if the number of homes sold declines, prices should hold.  He articulated that the decline in the housing market will come in “residential investment,” which includes new home construction, repair and remodeling, and brokerage commissions on house sales. 

Foreclosure Rate Rising
While the above four factors indicate a soft landing for the housing market, a potential problem that could become a larger issue is the foreclosure rate.  There were 92,746 houses in foreclosure in May 2006, 28% higher than activity in May 2005, according to RealtyTrac.  Five states had 48% of the disclosures: Texas (15.6%), Florida (9.6%), California (9.4%), Illinois (6.9%) and Georgia (6.2%). 

With up to $1 trillion in hybrid ARMs set to readjust for the first time by 2007 according to the Mortgage Bankers Association, the foreclosure rate may increase as many borrowers have difficulty affording their higher monthly payments.  “There is a direct correlation between foreclosure sales and market activity,” said James Gaines, a research economist at The Real Estate Center at Texas A&M University.  “If the rate of appreciation is not there, then there is an increase in foreclosure sales.” 

As many credit unions have expanded their affordable housing mortgage options in the last few years, it is critical that they closely monitor these categories as the mortgage rates reset and the housing market settles.  The National Credit Union Administration recently added several new delinquency ratios to the June 2006 Call Report, so analysis on the delinquency ratios of various mortgage loan products moving forward will be possible. 

For more information on mortgage trends and credit union best practices, Callahan & Associates recently released its 1st Quarter Research and Data Report, which has a special emphasis on mortgage lending.