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No Down Payment For New Homes

Posted Saturday, April 4, 2009

Many news accounts in recent weeks touted a turnaround in the housing market. This turnaround was based on modest upticks in the February data on housing starts and new and existing home sales. As noted in last week's Housing Market Monitor, the February uptick was almost entirely a reversal of a sharp decline in the numbers for January.

If the February data is compared directly with December data, there is very little change. This suggests that the January data was likely depressed, primarily as a result of bad weather. Housing starts and sales that were put off in January, because of worse than normal weather, took place in February instead.

This view is supported by the new Case-Shiller price data released this week. The January data indicate that the rate of price decline is accelerating almost everywhere. The overall 20-City index fell by 2.8 percent in January. It has fallen at a 26.5 percent annual rate over the last three months.

Prices are now declining rapidly in all 20 cities. Charlotte, North Carolina, and New York tied for the best performance, with prices dropping 1.2 percent for the month in both cities. Over the last quarter, prices have dropped at a 20.4 and 16.6 percent annual rate in Charlotte and New York, respectively.

The biggest bubble markets continue to show the most rapid rate of price decline. In Phoenix, prices fell by 5.5 percent in January. House prices there have fallen at a 43.7 percent rate over the last three months. In Los Angeles, prices fell 2.9 percent in January; they have fallen at a 25.4 percent rate over the last three months. Prices in Miami fell 3.6 percent in January; they have fallen at a 29.3 percent rate in the last quarter.

Perhaps most noteworthy in the new data is how prices are now declining rapidly in the markets that had been holding up reasonably well. Prices in Portland fell 3.0 percent in January, in Seattle by 3.6 percent, and in Chicago by 4.4 percent. The annual rate of price decline over the last three months has been 27.1 percent in Portland, 32.7 percent in Seattle, and 34.7 in Chicago.

The rapid rates of price decline increase the risk of becoming self-perpetuating. Lower prices push more homeowners underwater, leading to more foreclosures and therefore increasing supply in already glutted markets. Lower prices also destroy home equity, leaving fewer homeowners with sufficient money for a down payment on a new home.

The rate at which this process of equity destruction is occurring is truly striking. For example, if a homeowner in Washington, D.C. had equity equal to 30 percent of the market value of their home last January, the 19.3 percent decline in house prices over the last year would have destroyed almost most two-thirds of this equity. If the sales costs come to 7.0 percent of the sale price, then the owner would be able to pocket an amount of equity equal to just 5.0 percent of the January 2008 sale price. Unless this homeowner had a substantial pool of savings, they would not be able to afford a 20 percent down payment on a new home.

Of course, prices in many cities have fallen more rapidly than in Washington, D.C., and many homeowners had much less than 30 percent equity in their homes even before house prices started crashing. This means that many current homeowners will find it every bit as difficult getting a down payment as first time homebuyers.

It is also worth noting that relatively new homeowners are far more likely to be moving than those who had accumulated substantial equity and are likely to be older. In other words, the families that still have substantial equity in their homes even after the recent price plunge are likely to be older homeowners with no plans to move. This means that the set of potential buyers in many former bubble markets has fallen sharply in the last year and will continue to decline at a rapid pace as prices decline further.
By Dean Baker