Following the Numbers....

In a follow up to yesterday's somber post, I thought I would review the numbers and try to determine the implications of a possible change in FHA lending and interest rate increases.

What I found was pretty surprising.  Here are the results in an easy to digest graph form (click to enlarge):

This first graphs shows the minimum out-of-pocket expenses allowed under FHA rules.  The best case scenario for current buyers it to put 3.5% down on the home and have the seller pay closing costs.  Under proposed changes to the guidelines, buyer's closing costs would increase by .5% of the purchase price and sellers would only be allowed to pay up to 2% of the purchase price in buyer's closing costs.  On top of that, buyers would need to bring 5% of the purchase price to closing for a down payment.  The premium price scenario is slightly better since the interest rate on the loan could be increased so yield-spread could be used to pay for some closing costs.  However, given yield-spread's limitations, its not a huge help.

These simple changes to FHA guidelines would more than double what current buyers need to bring to the table.  If these changes take place, expect to see a buyer's exodus out of the market because they simply haven't saved enough cash to buy a home.  Although I support FHA tightening its belt, it means Realtors will need to tighten theirs too...yet again...
 

The next chart demonstrates what kind of payment shift our market may experience over the next year or so as interest rates increase.  The Fed is scheduled to stop buying Fannie Mae and Freddie Mac mortgage debt in March of next year.  Also, in April, the first time home buyer tax credit is set to expire.  The tax credit doesn't affect interest rates, but interestingly, demand for housing should peak with the expiration of the tax credit just as the Fed starts to allow mortgage rates to increase.

The chart above shows you what a payment would be like for a $100k purchase given different interest rate scenarios combined with a change in FHA rules.  Rates are expected to jump just a half a point.  However, market forces may push them up higher later.  The implication is that buyers qualifying for first time homes are going to want to keep thier payments within thier budgets.  If they can't increase their payments, they need to buy less home.

Hence, our next chart. This chart reveals what a buyer's payment on a $100K home is today versus what that very same payment will buy them under new FHA guidelines and higher rates.     

 As you can see, if rates just go up to 6.875% instead of today's 5%, the same family that bought a 100K home will only be able to afford an $83K home.  I can tell you there is a pretty big difference between a $100,000 home and a $83,000 home.

This downward shift in purchase power would apply across all classes of homes.  It means that people will be compensated for coming to the closing table with larger down payments. The more down...the lower the payment.  It makes sense.

I don't think we are in for a shock in interest rates. However, what I do believe we are in for is a slow but steady increase in rates as our economic equilibrium finds itself and we get back to the old-timer practice of putting money away for savings.  The big shock, if it comes, will be the changes to FHA.

Like the good squirrel, I am stashing nuts away in my tree for such an occasion.