What Does This Market Need? How About More Highly Leveraged Home Buyers?

| About: SPDR Homebuilders (XHB)
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Summary

Low-down-payment options are expanding the pool of potential homebuyers to include more people who don’t have enough for a traditional down payment.

Expanding the options should help some potential buyers leverage into new homes at high prices and higher interest rates.

Sellers looking to unload and buy new properties can see artificial gains to their net worth and real gains to their expenses.

This kind of strategy is excellent because the United States has seen nothing but success in the housing market for the last 200 years.

By finding ways to support housing prices without encouraging low interest rates, the Federal Reserve won’t need to play such an active role in managing interest rates.

Great news for American economy. The Federal Housing Administration released a new report that shows mortgage insurance is doing great. Due to the low level of delinquencies, it should be possible to expand the program to more buyers. The timing is ideal because home prices are at record highs. Home prices were facing a substantial headwind as interest rates moved higher and put the desired houses out of reach for many potential buyers. Since many of those potential buyers would no longer qualify for the houses they wanted due to the income / recurring expense ratios, new buyers were needed.

New Buyers

Expanding the option for low down payments won't do much to help those who cannot afford the interest payments. However, it does mean potential home-buyers with solid income but very little down payment will have more options to leverage into a more expensive house. By buying a more expensive house with less money down and higher interest rates these lucky home owners will be able to avoid having other disposable income that could distract them from living life to the fullest.

Great for Sellers

The news is also great for sellers. Home-owners who are selling their property now mostly fall into two groups. Either they owned the property free and clear or they owned it with a mortgage that carried a lower interest rate than their new loan will carry. Technically, there will have to be at least a couple people that were still paying exceptionally high rates on their mortgages and refused to refinance out or to sell the property and buy a new one at the much lower rates available over the summer. (Serious paragraph)

For the home-sellers who are going to be buying new property with more expensive financing, the support for housing prices will help them get the top dollar for their property. Of course, they will also need to pay top dollar for the new house they are buying. Fortunately, if the prices are a little inflated on both sides it means the equity allocation of the purchase price will be larger. Imagine you have a loan for $300k on your house. If you're selling the property for $400k and buying a new one at the same price, excluding transaction fees, you would have $100k in equity. That is a solid 25% down. However, if prices fell and you were selling for $350k and buying for $350k, you would only be able to put 14.3% down. Clearly, the increase in equity is good for all of us. It even stimulates the economy by ensuring all percentage-based fees (like realtor commissions) come off a higher value.

Great for Local Governments

The news that access to low-down-payment mortgages could be expanded is also great for local governments. If it supports house prices, it can support property taxes. That is a huge net gain for society because the home-owners clearly have no other use for that money.

A Pristine History

The final piece that really brings this all together is the knowledge that in the last 200 years there hasn't been a single period where housing prices declined in America. The consistent growth in housing values, which can often slightly outpace inflation, creates an absolute guarantee that these loans could never go bad. Because housing values only go up, and never ever rapidly decline or lead to great recessions, highly leveraged ownership by investors with few other capital resources should deliver exceptionally strong gains for their net worth and eliminate any risk of bankruptcy.

Credit Risk Transfers

There is a new investment available to investors known as Credit Risk Transfers. These brilliant securities allow the market to take on the risk of mortgage loans defaulting. This is an entirely new concept, because we've never created ways to bet on the success of risky mortgage loans before. Perhaps even better is the fact that many of these securities created over the last several months are already valued at a material premium to par value. So long as no one defaults, everything will be great.

Investing Implications

The price support that can be established by allowing greater leverage should be great news for home builders. It should also, at least temporarily, help to support employment growth because it will keep builders starting new properties. Eventually the higher interest costs on higher loan balances should create a slight headwind to spending in other parts of the economy. Don't expect the full impact to show up in the first few months though. Employment growth may appear negative in the near future because recent readings were strengthened by classifying more people as not being part of the labor force. (Serious paragraph)

Perhaps even more importantly for bond investors, it eliminates one of the factors that would have created a check against the rapidly rising interest rates. If interest rates were to get too costly and home sales fell rapidly, it would've created an incentive for the Federal Reserve to step back in and try to stabilize the housing market with lower interest rates. This strategy provides an alternative where home prices can be supported even without lowering interest rates. (Serious paragraph)

Now if we could just dramatically loosen the requirements on income to recurring expenses or stop verifying the income of home buyers, then we could really see housing prices soar.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Any paragraph that wasn't labeled as (serious paragraph) is primarily sarcastic and may include statements that are factually inaccurate by a substantial margin.