The Housing Market Index index is a monthly survey of 300 homebuilders to gauge demand for new home construction, and their corresponding confidence. New home construction has historically contributed roughly 5% to gross domestic product and is therefore a strong proxy for economic growth.
Notwithstanding the impacts of sequestration, or the collateral damage resulting from a default by the United States on its financial obligations—favorable demographics trends, compelling affordability rates, and depressed inventory levels of both existing and new homes bode well for continued overall strength in builder confidence.
Driving demand, household formation rates are breaking out of their nearly five-year slump and are expected to increase by 1.2 million new household formations in the upcoming year as economic conditions and prospects continue to improve. Juxtapose that number with the over 800,000 new homes being constructed on the supply side of the equation and you have a very positive correlation.
The availability of credit across the credit and income spectrum will have a large impact on whether households decide to rent or buy in the upcoming year.
Case in point, the December HMI saw strong sustained growth for the eighth consecutive month, but cited the tight credit market as the largest obstacle to a robust housing market recovery. With the new ability-to-repay/qualified mortgage rules from the Consumer Financial Protection Bureau released last week, along with the anticipated tightening of Federal Housing Administration underwriting standards, it is very likely that the problem of the shrinking credit box and the unyielding regulatory burden for originators will have a distinctively negative impact on the HMI and other housing indicators in the upcoming months.
Builder confidence, as measured by the HMI, may break from its three-quarter increase this month in January. In December, the HMI boasted its eighth consecutive month of improvement. The index, calculated by the National Association of Home Builders and Wells Fargo, measures current sales expectations, sales expectations for six months in the future, and prospective buyer traffic. NAHB noted in their December release that tight credit remains the largest obstacle to growth in the housing market, saying that the “one thing that is still holding back potential home sales is the difficulty that many families are encountering in getting qualified for a mortgage due to today’s overly stringent lending standards.”
Unfortunately, the new regulation issued by the CFPB just last week and the new more conservative underwriting of FHA loans will raise the bar to qualify for prospective homebuyers.
On Jan. 10 the CFPB issued the much-anticipated final ability-to-repay/qualified mortgage rule. The final rule, scheduled to be effective January 2014, codifies eight requirements for lenders to verify a borrower’s ability to repay. The rule also establishes two QM constructs with more legal protection for lenders. For the safest, highest credit quality borrowers, the rule creates a safe harbor, and for higher-cost or less prime borrowers the rule establishes a rebuttable presumption of compliance.
Following the release of FHA’s Actuarial Report, which revealed that the agency was on relatively unstable financial footing and concerned congressional response, FHA announced plans to tighten underwriting standards required for FHA insurance. Earlier this month, FHA announced an increase in the upfront fees charged to borrowers from 1.75% to 2.25%. FHA will also begin to require borrowers with a credit score of less than 580 to pay a ten percent down payment. These changes will be effective this spring.
In today’s housing market, where FHA, Fannie Mae and Freddie Mac dominate the mortgage insurance and purchasing space, it is reasonable to expect that if and when the private market returns, it will act conservatively until it is compelled up the risk curve by market or economic forces. Furthermore, it is likely that investors will gravitate toward loans meeting the QM safe harbor standards, or at least the QM rebuttable presumption criteria, and other stringent underwriting guidelines such as the FHA changes. This “race to the top” in mortgage lending standards will only further contribute to the credit problem in the short run.
Although the new rule and underwriting guidelines are not yet effective, they will likely begin to impact market expectations sooner as opposed to later in anticipation of the changes. We can expect these changes to manifest themselves as headwinds to forward-looking housing indicators in the upcoming months.
Tim Rood is partner and managing director of The Collingwood Group in Washington.