These People Could Cause Another Real Estate Crash

The real estate market has performed pretty well over the past couple of years, with the average U.S. home price about 27% higher than the 2012 lows. So, this means we're out of the "danger zone", right?

Not so fast! There are still a few things that could very easily end the housing rally that we need to keep an eye on, and one of the biggest hazards is first-time homebuyers staying out of the market, which is already happening.

With the recent data indicating the market is slowing down, it is more important than ever to watch for signs of trouble.

First-timers are an important part of a healthy housing market
Historically, first-time home buyers have made up about 40% of the market and this has dropped recently. According to the National Association of Realtors, 38% of 2013 U.S. home buyers were first-timers, and the percentage declined throughout the year, dropping to as low as 27% in December, the lowest percentage since they began tracking the percentage in 2008.

There are several reasons first-timers might be struggling to afford homes. Higher prices, tight credit, poor employment prospects, and high debt could all be keeping first-timers on the sidelines.

Mortgages are either tough to get, or unaffordable
Up until a few years ago, the traditional route for first timers, FHA loans, were much more affordable.

Not only has the upfront mortgage insurance premium nearly doubled from 1% to 1.75% of the loan amount, but the annual mortgage insurance must be paid for the entire life of the loan. With an FHA loan, an interest rate of 4.5% actually works out to an effective APR of closer to 6%. For a comprehensive discussion of how much more expensive an FHA loan is, here is a thorough discussion

Conventional loans typically require a 20% down payment, which is getting tougher for first-timers to come up with as prices rise, and credit requirements are very high. The average FICO score for a conventional purchase loan is currently 755, and the average rejected credit score is 724, which is well in the realm of "excellent" credit.

Poor job market for younger people
Adding to the unaffordability of homes for first-timers is the difficulty of finding a good job. The unemployment rate for recent college grads is 8.5%, well above the national average, and another 16.8% are underemployed. The situation is even worse for younger adults who didn't graduate college, with some reports putting the unemployment rate for those under 25 with just a high school diploma at a staggering 30%.

So, even if young, potential first-time buyers have the credit and down payment, they won't have much luck obtaining a mortgage without the income to justify the loan.

As debts rise, less younger people will be able to buy
It's no secret that student loan debt has grown tremendously over the past couple of decades. The debt may or may not be worth it to obtain a degree and (theoretically) a higher paying job, but what's certain is more debts make it difficult to buy a house.

However, it's not just student loan debt we should be concerned about. The average "millennial" (ages 22-33) spends 12% of their take-home pay on student loans according to a recent survey, which is surprisingly not the biggest debt burden they have.

Credit card debt is often the biggest problem for younger adults, and eats up about 16% of the millennials' take home pay, on average.

Most mortgage companies shoot for total debt-to-income ratios below 36% for conventional loans, so if 28% of millennials' income goes to paying off student loans and credit cards, it doesn't leave much room to take on a mortgage.

To sum it up, home sales are still below what's considered a "healthy" level, so the market can't afford to see this huge group of buyers disappear. Any further drop in the percentage of first-time homebuyers in the market could be a warning sign for the housing market.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 22, 2014, at 7:49 PM, MrHouse63 wrote:

    This article as far as mortgage requirements was very poorly researched. I am a Senior Loan Originator, and the misinformation in this article astounds me.

    Since I work for one of the top Mortgage companies in the US, I will address a few Items.

    The authors basic information of FHA mortgage insurance is not far off.

    However, the contention that you need twenty percent down for a conventional is plain wrong. Conventional loans can be done as little as 5% down. and in many cases that can be a gift.. Credit scores can be as low as 620, even on a conventional loan.

    Also I don't know of any mortgage banks that limit total Debt to income to 36% including the mortgage, so saying "Most Mortgage banks" is flatly ignorant.

    If the Motley Fool would like, they can contact me and I will write a factual article on mortgages

  • Report this Comment On June 22, 2014, at 9:06 PM, parareaper wrote:

    Realtors will contribute to the next real estate crash

  • Report this Comment On June 23, 2014, at 2:05 AM, Heywood wrote:

    Most mortgage companies shoot for total debt-to-income ratios below 36% for conventional loans, so if 28% of millennials' income goes to paying off student loans and credit cards, it doesn't leave much room to take on a mortgage.

    Especially after they pay for gas, food and health insurance.

  • Report this Comment On June 23, 2014, at 12:58 PM, Revernedbob wrote:

    The next real estate crash will be caused by the same thing that caused the previous crash, which is that the residential real estate market has been turned into a speculative arena in which a commoditized "product" is bought and sold as if it were a share of common stock or a bushel of wheat!

    At the moment the most destructive force in the market are the Wall Street equity firms that have been buying up distressed properties by the thousands and fire-sale discounts with the expectation that they will be able to flip them for a quick profit or hold them as rentals, thereby driving up rents once they corner the market.

    In order to have a sound housing market the speculative aspect must be mitigated either through regulation of the speculators or by tipping the market balance in favor of buyers who are true "consumers" of housing; i.e. people who are buying a house because they plan to live in it.

    Personally, I favor a combination of the two as it is likely that this is what it will take to reign in the predatory investors who have no concern for whether or not the market remains stable as long as their short-term investment objectives are met. Which in most instances means they are in favor of unrealistic appreciation rates and the loose credit environment that greases the wheels of rampant appreciation in homes prices.

    Unless and until the federal government does step in and take the necessary measures to curb the activities of the speculator class, the housing market will continue to be a roller coaster of rising and falling prices with the end result being that more and more Americans will be shut out of the opportunity to own a home as prices continue to spiral out of reach of the average working family.

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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