Question corner: When do things get back to normal?
I'm a buyer waiting for real estate to return to normal. Shouldn't that happen soon?
I've been asking myself that too. We seem due and then some. In the past, whenever the number of residents in this area who can afford the median-priced home has dropped below 20 percent, it's meant that prices have peaked for that cycle. But affordability has been at or below 20 percent for two years, and still home prices go up. What's different this time?
First, bear in mind that this area's market may never be normal in the sense that say, the market in Dallas or Des Moines is. The San Francisco Bay Area has such a limited supply of homes that even a small increase in demand is magnified exponentially. The pendulum also swings the other way, making for a roller coaster market.
Also bear in mind that when you talk about things getting back to normal, the new normal isn't necessarily going to look like yesterday's normal. Yes, I know, this sounds too much like the "this time, it's different" hype that led so many stock market investors over a cliff in 2000. But markets do change how they operate, even as the fundamentals stay the same.
This time the difference is new "loan products" with payments designed to stay affordable, one way or another. More aggressive loans, easy credit and rock-bottom interest rates have kept buyers in the market even as home prices have appreciated in double digits. Homebuyers don't necessarily use prices to judge affordability; they use loan payments. As long as the monthly payments look do-able, rising prices actually make home buying look like a safe bet.
When the California Association of Realtors® says that less than 20 percent of us can afford the median-priced home in the San Francisco Bay Area, it's assuming something that isn't always true these days: that buyers are using that most expensive of loan products, the 30-year fixed-rate fully-amortized loan. Long considered the gold standard, the thirty-year fixed-rate loan protects the borrower from the risk that her house payment will rise over the life of the loan. But that protection comes at a high price—the borrower pays a higher interest rate that reduces her home-buying power.
When home prices rise faster than income, Mary Borrower may not be able to afford the luxury of fixed loan payments. Desperate times call for mildly desperate measures, so Mary switches to a riskier adjustable rate mortgage (ARM) with a lower initial interest rate and lower monthly payments. Or maybe she goes even more aggressive with an "interest-only" or "option payment" loan. Thus armed, Mary outbids five other buyers and incidentally sets a new record for home prices in the neighborhood. Multiply Mary by thousands of other buyers and you have another month of rising prices.
Like any industry, the mortgage industry tailors its products to changing conditions. The irony is that some of its "new" offerings look just like the loans of seventy years ago, before the advent of the thirty-year fixed. Is this another "paradigm shift" similar to that of the 1930s, or is it just an expedient way to sell more loan products?
And will aggressive borrowing be enough to keep the real estate market booming? Or will it simply soften real estate's eventual landing?