What is preventing a real estate market crisis in the U.S., even as new mortgages come with exceptionally stringent terms and interest rates reach their highest levels in 25 years?
The Impact of Low-Interest Rates on Mortgage Debt
The underlying debt benefits from low-interest rates: total mortgage debt in the U.S. is $13.3 trillion, and these mortgage rates have remained fixed. Approximately 92% of this debt was purchased or refinanced during a period of low to moderately low-interest rates that will last through September 2022.
Record low loan-to-value ratios for real estate. Between 2006 and 2009, the catalyst for problems in the mortgage market was the collapse in real estate prices, which exacerbated structural imbalances. Now real estate prices are at historic highs, which creates a mortgage debt to real estate value ratio of 26 - 27% - comparable to the minimum values of the mid-1980s and almost twice as low as in 2008 - 2010.
Economic Conditions and Trends
U.S. real personal income growth rates are currently in line with the historical 2010 - 2019 trend, whereas in 2008, incomes began to decline as early as February 2008, accelerating the rate of decline with each passing month.
Current spending on residential real estate in the primary market is about 900 billion per year, compared to 1.05 trillion at the peak in Q1 2022. This is much higher than the peak of spending in Q1 2006 (770 billion), but personal income has grown substantially.
Enhanced borrower quality is notable. During the period from 2006 to 2009, numerous borrowers obtained mortgages burdened with high levels of debt and low income, resulting in a rise in mortgage defaults and the subsequent collapse of the mortgage market. Currently, the weighted average debt-to-income ratio is significantly improved compared to what it was 15 years ago.
Stricter borrower requirements and increased regulation of the mortgage market. Dodd-Frank Act, Financial Services Modernization Act, Mortgage Debt Consumer Protection Act, etc.
Conclusion
Despite tight mortgage lending conditions and rising interest rates, existing mortgage debt benefits from historically low rates, low loan-to-value ratios, reduced structural imbalances, stable economic conditions and rising household incomes, improved borrower quality, and increased regulatory measures in the mortgage market. All these factors together contribute to market stability and reduce the risk of a crisis in the near term.