There are two vying perspectives in the real estate market. The first theory argues that the housing market will remain strong, as consumers are expected to use their home equity loans and lines of credit in the coming months for holiday purchases, debt consolidation and to lock in rates before they rise further. The second theory warns of a slowdown in home sales and highlights an accident-prone economy that is reliant on continued house price appreciation. There is ample evidence to support each argument.
Housing Remains Strong
The Office of Federal Housing Enterprise Oversight (OFHEO) announced on November 29, 2005 that it will raise the 2006 single-family conforming loan limit by 16 percent to $417,000. That is the largest percentage increase since 1980. The move expands Fannie Mae and Freddie Mac’s influence as it is predicted that the move will make an additional 466,326 consumers eligible for a conforming loan.
Additionally, the OFHEO announced that national house prices appreciated 12.0 percent for the 12 months ending September 30, 2005. Credit union real estate loans followed a similar trend, growing 13.9 percent for the 12 months ending June 30, 2005. Many analysts expect consumers to leverage their equity for holiday purchases, but at a slower rate than in the past few years. The FDIC recently released a study stating that banks’ home equity portfolios grew $4.3 billion (0.8 percent) in the third quarter, the slowest growth rate in four and a half years.
But a Slowdown is Projected
A sign of a housing slowdown is that the number of existing houses on the market increased 3.5 percent in October to 2.87 million according to the National Association of Realtors. The existing inventory is at its highest level since April 1986. At the same time, existing homes sales declined 2.7 percent to a seasonally adjusted annual rate of 7.09 million. At that pace, it would take 4.9 months to sell the current supply. Mark Zandi, chief economist of Moody’s Economy.com, said recently in a Washington Post article that “… with rising inventories of unsold homes, house price growth will slow sharply in coming months.”
The current slowdown may even be understated. Several economists have argued that the actual decline in house sales will continue further due to the effects that Hurricanes Katrina and Rita have had on the housing market. These natural disasters could delay the housing slowdown until the latter half of 2006 as FEMA and insurance companies begin to distribute the billions of dollars allocated toward the region. As a result, the Mortgage Bankers Association predicts that the second half of 2006 will see a decline in production activity.
Financial institutions have had their balance sheet portfolios affected as well. Northern Trust Company’s chief economist Paul Kasriel observed in a recent article in The New York Times that 61.7 percent of banks’ earning assets consisted of mortgage-related holdings as of the second quarter this year, up from 48 percent in 1995. In contrast, credit unions have 37.3 percent of their earning assets in mortgage-related holdings, up from 24.8 percent in 1995. If house prices flatten, credit unions in the next few quarters may have a smaller percentage of mortgage-related holdings on their books. This will affect their asset liability management assessments as there will be a different mix of assets. Mortgage-related holdings are traditionally considered safer options than credit card or auto loans, which may increase the risk assessment of the portfolio.
Watch out for those Option ARMs
While only a handful of credit unions offer an Option Adjustable Rate Mortgage, banks had been falling in love with the product in the last few years. An Option ARM entices consumers with a low introductory rate that typically lasts for only one to three months. Borrowers have four payment options each month that include a minimum payment, an interest-only payment or a standard amortizing 15- or 30-year payment. The mortgage product is targeted toward the financially sophisticated borrower who understands the risks, which include negative amortization and a possible payment shock.
Lately, however, banks have become less enamored with the Option ARM. One reason for the decline is that, as rates rise, consumers are deciding that a fixed rate mortgage is a more appealing option. As reported by The Wall Street Journal on November 29, 2005, Option ARMs at Washington Mutual Inc. accounted for 29 percent of mortgage volume as of the third quarter this year, down from 40 percent a year ago.
Credit unions should continue to avoid offering Option ARMs in this rising rate environment as members may be in for quite a surprise when their rate adjusts.
No matter which perspective holds more weight, credit unions should prepare for slower real estate loan growth in 2006, unless of course they have branches in the affected hurricane regions. Higher interest rates in the near future may slow down the purchase market as consumers will be wary of both high home prices and rising mortgage rates.