This month we reflect the impact caused by subprime lending, which at its height allowed borrowers to qualify for loans that were approximately twice what they could have qualified for with current lending standards. A client recently lamented that the offer we were presenting for his property was less than what it cost to build the house. If the value was there, why was no buyer willing to pay? Most people probably assume that the housing market will at some point go up again, but while incentives, low interest rates, and falling prices have spurred the market for homes below $200,000 to approximate that of 2006, sales of homes priced from $300,000 to over $1 million are more than 50% below the levels of 2006.

The Wall St Journal finds a bunch of reasons why there are “Fewer McMansions on the Horizon”.  For instance, they note that people are buying smaller houses because of demographic changes. However, they don’t connect the dots pointing at the change in lending practices, which, despite low interest rates, has greatly reduced the number of buyers who qualify for the higher price ranges. The left over new construction product, geared to be profitable because a large segment of our population could afford to purchase McMansions, now fall in price because the loan qualification income bar has been raised considerably, creating a scarcity of buyers.

Despite the current improvements in the low end of our housing market, affordability has been severely restricted compared to the bubble years, when exotic and risky lending practices greatly expanded buyer’s borrowing capability, resulting in a much larger pool of buyers for higher priced homes. This is described clearly in Marc Hanson’s blog, where he states:

In a nutshell, loan types such as zero to 5% down $500k Pay Option ARMs with a payment rate of 1% and loan features such as stated income made houses very affordable. Houses were so affordable due to leverage in finance that if a buyer could only afford a $300k house on a 30-year fixed, a quick loan type change would double his buying power. This is not the case any longer — today, buyers can only buy what they can afford and qualify for based upon income, assets, debt load and credit. They can’t reach outside of their affordability bands any longer.

In the boom years many $400,000 homes were sold to buyers with household incomes of $50,000, while today, even with record low interest rates, a buyer with $75,000 in household income must struggle to afford this loan, especially the down payment. This reduction in the pool of buyers means not only that these more expensive homes will sell for less, but that the distribution of homes in future new construction developments must also change to accommodate the reduction in borrowing capability. Restoring full employment and a robust economy won’t cause a return to the old market because the lending programs that allowed buyers to borrow up to twice as much as with today’s loan programs are no more.

Compare year-to-date closed sales in 2009 with 2006 (when exotic loans were still widely available) in the table and graph below. Although sales $200,000 and below compare well in 2009 with 2006, between $300,000 and about $1 million current sales are only about half what they were in 2006. Unlike then, despite lower interest rates now, buyers must now provide down payments, must prove their income, and no longer receive super low teaser interest rates on their loans.

 Year-to-date Kitsap Residential Sales - 2006 vs 2009

Price range	2006	2009	%diff 2009 vs 2006
0-100k	26	66	+153%
100k to 200k	533	492	-8%
200k-300k	1378	819	-40%
300k-400k	631	311	-51%
400k-500k	279	126	-54%
500k-600k	161	56	-65%
600k-700k	86	43	-50%
700k-800k	58	22	-62%
800k-900k	46	17	-63%
900k-1000k	35	11	-68%
1000k-1250k	28	13	-53%
1250k-1500k	8	9	12.5%
1500k-1750k	6	3	-50%
1750k-2000k	2	1	-50%

Note that in this same $300k - $1 Million range the shape of the 2007 (when the number of listings and the median sales price were near peak) and 2009 listings for sale showed a slight bulge in inventory compared with the shape of the curves for listings sold. Also see how the inventory in this price range has fallen in 2009 compared to 2007, while the inventory in the $200k and under market is larger now than it was in 2007.

The Washington Center for Real Estate Research provides local affordability calculations that we can use to check on housing affordability using current median prices and interest rates. Note that unlike the discussion above these calculations only compare the affordability of standard conventional loans, not the different types of loan products that have been offered. We assume that a buyer making the median family income puts 20% down on the median priced home and obtains a 30 year fixed rate mortgage. We assume that a first time buyer making 70% of the median income puts 20% down on a house priced at 80% of the median and obtains a 30 year fixed rate mortgage. We assume that both buyers can afford to spend a maximum of 25% of their monthly income on the principal plus interest of the loan. Using the annual averages of median price, median income, and average annual 30 year fixed interest rate since 2003, we plot an affordability index equal to the maximum affordable payment divided by the actual payment. When the index is greater than 1, the loan is affordable to the typical buyer. When it is less than 1 some buyers cannot afford to purchase. Our numbers for 2009 are estimates using the latest monthly data for median prices and interest rates (2008 has been updated with average annual values), and an estimated median family income for 2008 and 2009. With interest rates falling from 5.22% last month to 5.15% in October for a typical 30 year fixed rate conforming loan and the median price rising a couple percent in October to $250,000, affordability is very good. Keeping in mind how median prices can be deceptive, you should be aware that the bulk of sales are concentrated below $400,000, with considerably fewer than normal in the higher price ranges. The affordability index degraded slightly to 1.24 in September from 1.25 in August. First time buyer affordability degraded to 1.08 from 1.10 last month. Below is a  graph of the year-to-year changes in affordability and a second graph showing month-to-month affordability progress over the past year.

Year	2003	2004	2005	2006	2007	2008	2009
Annual Average interest rate	5.83	5.84	5.87	6.41	6.34	5.80	5.15
Median Income	$53,160	$53,923	$54,582	$58,304	$60,719	$65,000	$65,000
Median Price	$184000	$206900	$250000	$275000	$290343	$265000	$250000
Monthly payment	$867	$975	$1182.43	$1378	$1443	$1244	$1092
Affordable payment	$1,108	$1,123	$1,137	$1,215	$1,265	$1,354	$1,354
Affordability Index	1.28	1.15	0.96	0.88	0.88	1.09	1.24
1st time buyer payment	$693	$780	$946	$1102	$1155	$995	$874
1st time buyer affordable payment	$775	$786	$796	$850	$885	$948	$948
1st time buyer affordability index	1.12	1.01	0.84	0.77	0.77	.953	1.08

October's APR is 5.191% on a 30-Year and 4.700% on a 15-Year, both Conforming. September's rates were the same. If you qualify for FHA or VA loans (or the newly popular USDA loans), these programs have are attractive for low downpayment buyers. Limits for FHA and conventional conforming loans went up with the stimulus bill signed earlier this year. FHA maximum is $475,000, and the conventional conforming limit has returned to $475,000. Lending programs for jumbo loans have improved considerably, with the larger banks starting to come back to this market. A typical 30 year fixed jumbo APR (with total costs of the loan, not just the rate factored in) is 5.895% on one major bank web site. Local credit unions and savings and loans may be able to beat this rate for some jumbo loans. To check the daily rate you can contact your lender or preview web sites such as this one - http://bankrate.com/.