Lower Downpayments May Augur Higher Default Rate

A study released by SMR Research revealed that 38% of people who purchased homes in the first six months of 2005 put less than 5% down on the purchase price. According to the report, researchers stated rising home prices combined with small downpayments may cause an increase in future foreclosures.

Additionally, the Office of Federal Housing Enterprise Oversight recently released their numbers, revealing that average U.S. home prices increased 13.43% from the second quarter of 2004 through the second quarter of 2005. Appreciation for the most recent quarter was 3.20%, or an annualized rate of 12.8%, which is the largest house price increase in more than 25 years.

"There is no evidence here of prices topping out," said OFHEO chief economist Patrick Lawler. "On the contrary, house price inflation continues to accelerate, as some areas that have experienced relatively slow appreciation are picking up steam."

So, is there a cause for concern? Will this lead to more foreclosures and higher prices?

Karl Case, a professor of economics at Wellesley College, said that there is probably cause for concern, but is uncertain to who will bear the burden, whether it's the buyer, Wall Street or banks.

"It's a scary period for people in the market. There's no saying how these high prices will work out," said Mr. Case. "There's half a trillion dollars in the subprime market [that's] untested. Prices are simply not going to turn down," he added.

However, Mr. Case does not believe that the sky is falling just yet. "People said two years ago they were getting into these higher-ratio loans, but the market's gone up."

Mr. Lawler also added that, despite these price increases, they wouldn't go up indefinitely. "The continued price increases are a result of many factors including low mortgage interest rates and the apparent impact of speculative investing," he said.

"The robust appreciation rates are striking both in terms of their magnitude and in their geographic scope. However, they are likely unsustainable given the underlying inflation rate, income growth and other factors."

"The more troublesome thing to me is the shift to adjustable-rate loans. If loan rates do go up, adjustable-rate mortgage holders have payments go up, and sometimes they have to sell," said Mr. Case.

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