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Posts Tagged ‘4.5% Rates’

There has been a lot of buzz going around about a plan to reduce mortgage rates to 4.5%. While none of us knows what is going to be implemented, I can say that I don’t believe 4.5% interest rates are going to save the housing market because low rates do not address the root cause of the current housing market stagnation.

The housing market isn’t suffering from high interest rates. Rates have been at near historical lows for the past six years. The bottom line is that if you can’t afford to buy with 30 year rates at 6%, you can’t at 4.5% either.

The housing market is suffering the consequences of loose lending and an oversupply of homes. Over the past seven years or so, mortgage products allowed people to afford bigger mortgages due to a combination of low interest rates and less strict guidelines such as lower down payments and even lower credit scores. When money is falling off the trees, borrowers are not as price constrained as they would be in a normal market. This leads to ever increasing home prices.

In addition, developers turned every cornfield they could find into the hottest new development to meet the demand from consumers. Condo developments popped up on every street corner in urban areas. Not only were Joe Plumber consumers buying homes, but also Donald Trump wannabes which further inflated prices.

Eventually, supply begins to exceed demand. As any 10th grader taking economics will tell you, when that happens prices must come down. In the case of the housing market, supply begin to exceed demand and to make matters worse, the liquidity that fueled the demand also begin to dry up. In short, the housing market had the rug ripped out from under it. Banks drove home prices sky high with loose lending and then shut off the spigot abruptly with ever increasingly strict underwriting guidelines.

A 4.5% interest rate won’t help anyone if you still need a 40% down payment and a 800 FICO score to qualify or if there are still way too many houses on the market relative to the number of buyers.

If we want to get the housing market stabilized, we need a moratorium on building new homes so that the existing inventory can be worked through. In addition, the government needs to provide reasonable incentives to make buying an attractive alternative to renting for credit worthy borrowers. For instance, the government should consider providing down payment grants. We also need some incentives to encourage the purchase of foreclosed homes.

I don’t pretend to have all the answers, but I do know artificially lowering interest rates will not stop this train wreck.

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