The housing market has been on a roll recently, with some markets even recovering to their peak 2006 levels. That sounds good, until you remember what 2006 was like. In retrospect, it seems clear that those prices were overly inflated by a boom mentality. Can the same be said for the housing market now?
So far, home prices have been rising at a more measured pace than they were back in the frenzy of the housing boom. Still, there are at least five reasons to be cautious about the housing market.
1. The Fed is no longer keeping mortgage rates down
Quantitative easing is over. While the Federal Reserve is still keeping short-term interest rates near zero, it has discontinued the monthly bond purchases that were designed to push longer-term rates down. This was an important influence in getting mortgage rates to record lows.
So far, mortgage rates have been surprisingly stable, but without the Fed actively keeping them lower, there is no reason why normal market forces could not quickly send them higher -- especially if there is a whiff of inflation somewhere along the line.
2. Prices have been rising for more than two years now
According to the S&P/Case-Shiller U.S. National Home Price Index, the housing market bottomed out in February 2012 and has been rising ever since. The good news is that prices still are not as high as they were in 2006, nor has the rise been as steep. However, the closer prices get to those levels, the more you have to ask what would make them sustainable now if they were not sustainable then.
3. Some loan limitations are being softened
The Federal Housing Finance Agency recently announced that it would allow Fannie Mae and Freddie Mac to back mortgages with down payments as low as 3 percent.
After the epidemic of irresponsible lending that went on during the housing boom, the government tightened loan standards. Higher down payment requirements made sure borrowers were more fit to meet their obligations, and would not be as exposed to fluctuations in home prices. By facilitating more low-down payment loans, the government is backing away from these cautionary measures.
4. A key banking safeguard has been eroded
Separately, federal regulators also announced they were easing a requirement that banks had to keep at least a 5 percent stake in mortgage loans they made. Risk retention requirements made sure banks had an incentive to make responsible loans. By letting banks completely sell off the risk in the form of securities, banks can free themselves of any ongoing responsibility for the loans they make.
5. Default rates are creeping back up
Mortgage defaults have slowed considerably over the past five years, but most recently they have risen for three straight months. They are still low, and it is too early to tell whether this change is a temporary blip or a true turning point. However, this is a trend worth watching.
The best way you can protect yourself from a setback in the housing market is to base your purchase decisions on what your income can readily afford, and not on the assumption that prices will keep rising. After all, buying a home means putting a roof over your head, and that should not be a speculative investment.
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