One of the "core drivers" of economic growth in the United States is the housing market. We recently experienced a slowdown in new and single-family home sales with the rise in interest rates we experienced toward the end of summer. With new challenges coming to the housing finance market in 2014 as well as the threat of increasing interest rates, I wouldn't be surprised if we experience a slowdown in housing sales again. If this takes place it has an adverse affect upon the market as well as individual companies.
Caterpillar (CAT) is one of the companies that could be adversely affected if the trend to buy homes starts to slow down dramatically. How would Caterpillar be affected? In mid-September, the company announced a 10% decline in global retail sales of its equipment. Not only does Caterpillar sell heavy equipment to mining companies, they also cater to construction. The companies that prepare the earth for new subdivisions as well as smaller construction jobs more than likely use Caterpillar equipment. When the new housing industry is not expanding, companies are not buying equipment from dealers that carry Caterpillar equipment.
There are a number of factors that are keeping potential consumers away from the new-home market right now. A combination of lower credit and stronger credit restrictions is driving lower income and younger households toward rentals and that's where they will stay. Because of this more Americans are also gravitating toward multifamily homes instead of buying single-family homes. Single family homes are the one catalyst for the sales of heavy equipment that companies like Caterpillar need.
Caterpillar is not the only company feeling the sting. New-home builders like PulteGroup Inc (PHM) and D.R. Horton (DHI) have also felt the sting of rising interest rates as new-home construction has slowed down.
With increased fear of rising interest rates, sales of previously owned homes in the United States continued to shoot up this summer as buyers attempted to lock in rates while they could. August saw the biggest increase in six years and this should lead to a slowdown as sales will cool soon. One of the reasons that the Feds recently decided to leave the stimulus in place was because new-home sales construction was weaker than expected.
BUYING BETTER THAN RENTING
It may not make much sense to compare buying a home compared to 20 years ago, but it makes more sense to buy a home today than it does rent one. Mortgage rates have risen, but they are still very low as in comparison to what they were before the housing bubble broke. Buying is less expensive than renting, and even though prices have increased a bit, it still makes more sense to buy.
Back in the late 1990s when interest rates dropped to 7%, that was a deal! But we don't compare what rates were a decade or two ago and just go out and buy a house. Consumers today will look at what rates are today and if the interest rate goes up too much, they just won't buy. If the interest rate is at 3.5% and goes up 4% you'll have a sizable slowdown in the purchasing of homes. This is one fear that pushed a wave of consumers to buy/refinance their homes in the summer. Even though it may make sense to buy instead of rent, that doesn't mean waves and waves of people, are going to continue to buy. Mortgage rates may look good but it's a lot harder to buy a home today than it was five or six years ago.
Often down payments have to be much higher, many people even with good credit don't qualify. Some who can afford it may not be able to buy while rates are this low because of qualifying problems.
THE CLOCK IS TICKING
Is there a chance that mortgage rates will drop again and we will see a torrent of people rushing to buy homes again? I don't think I can answer this question yet, but for the foreseeable future I don't think this is likely.
I do know that Fannie Mae and Freddie Mac are going to reduce the size of mortgages that are eligible for their backing. This is going to drive buyers who are looking for larger homes to private lenders. Whenever you get a private lender, they are usually more conservative and this translates into lower risk and larger down payments. This will lock some buyers out.
There are a slew of new mortgage rules that may lockout some potential buyers that have debt on the books that may have qualified otherwise. Honestly, it's just harder to get a loan and will continue to get harder.
In the days before the financial crisis, one could get a mortgage with no income documentation. We all know those days are long gone, but to get a mortgage today there are three things very home buyer needs:
- Stable incomes
- Equity or down payment
- Decent credit scores
There are a lot more hoops to jump through. One example is what banks might describe as "unusual deposits" to a checking or savings account. As a bank scrutinizes your account, if this is a "gift" that may have come in that looks "unusual" it is highly possible that they would make you prove you said what it is. A simple gift from a parent of $1000 put into account would be questioned.
While it is true the qualifications to get a loan are much harder today than they were five years ago, home buyers must also put up with more financial scrutinizing and paperwork which is a huge inconvenience.
Even though it is harder to qualify for a loan, there are still plenty of people out there buying homes that qualify. But mortgage lenders are running into more disqualifications than ever before. With the tightening of credit and the possibility of interest rates going up, it could put a large damper on new housing market-in turn, hurt construction.