Construction Accounting Article -
Tighter Morgage Standards Threaten Homebuilding Market
Target Audience: Construction Industry Professionals, Homebuilding Market, Morgage Standards Interest
Not too long ago, homebuyers had it easy. Lenders were handing out mortgages to most who applied — even those who couldn’t afford down payments or were unlikely to maintain their payments once early “teaser” interest rates went up. Although some of the financing was risky, a booming housing market meant people could buy homes, keep them until their adjustable rate mortgages (ARMs) were ready to adjust and then sell them at a profit. Those days appear to be over. Generally, housing prices have fallen over the past year, and many potential buyers are no longer able to readily obtain financing — and this is affecting the construction business.
Soggy sales
How bad have things gotten? Of the homebuilders surveyed by the National Association of Home Builders earlier this year, 44% said tighter lending practices had hurt their sales. The median loss reported was an estimated 15%. KB Home, the fifth-ranked homebuilder in the United States, reported an 84% drop in net profit for its fiscal first quarter, which ended Feb. 28. Some experts say the soggy sales were inevitable. Weaker lending standards in recent years sparked excessive demand and helped fuel the housing boom. And now that tighter standards are in place, the market has predictably fallen into a slump. The problem is most severe in the subprime lending market, where higher priced loans are marketed to people with credit problems or lower incomes. Particularly problematic are the ARMs, whose rates may jump dramatically out of reach for some ill-informed or unlucky borrowers. Someone who borrowed $200,000 at an introductory rate of 4%, for example, would pay about $950 per month in principal and interest. That might be affordable, but if the interest rate jumped to 7% after a year or two, the payments would become $1,320. Some borrowers simply can’t keep up.
Some good news
For homebuilders, however, there is some good news. Although lenders reported record mortgage delinquencies and defaults in 2006, the problem was largely confined to the aforementioned subprime market. The prime market, which comprises most homebuyers, hasn’t been significantly affected. Additionally, lenders are taking steps to help struggling homeowners avoid foreclosure — and to help prevent further weakening of the market. Fannie Mae and Freddie Mac, the government-sponsored companies that are the two biggest players in the home mortgage market, have agreed to buy billions of dollars in high-interest mortgages. That will give commercial lenders some flexibility to help strapped borrowers. Also Fannie Mae, Freddie Mac and a number of lenders — including Citigroup, JPMorgan Chase and Bear Stearns — have adopted principles for dealing with high-risk mortgage holders. They include contacting distressed borrowers to try to work out payment arrangements, making loans more affordable through lower rates or changing terms, and refinancing at the lowest cost possible for eligible borrowers.
Keen eyes
Ultimately, the best thing a homebuilder can have right now is a pair of keen eyes for changes in his or her local market. Learn to distinguish real opportunities from unreasonable risks — doing so isn’t as easy as it used to be.
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