America's housing market soared to record heights in recent years on easy credit and innovative financing. Now those forces are unwinding in ways that could exert a slowing influence on the housing market through this year and 2008.
A key symptom of the challenge ahead: Foreclosure rates are rising not just for risky subprime borrowers but for a range of adjustable-rate loans made in recent years.
Some 1.1 million homeowners who took out adjustable-rate loans between 2004 and 2006 will probably face foreclosure, according to a new forecast by First American CoreLogic, which tracks national housing markets. That number would surge to 1.9 million, the firm estimates, if home prices fall by 10 percent from where they began the year. In total, there are about 76 million owner-occupied housing units in America.
In itself, the problem isn't big enough to steer the housing market downward. It will take six or seven years for a scenario like this to play out. The affected home buyers and lenders bear the brunt of the financial damage. But foreclosures could create head winds that weigh against prospects for a housing-market recovery. It's not just that loan defaults add to the inventory of homes on the market. Potential home buyers also face an impact, one that is larger and more immediate: Lenders, in response to the credit problems, are tightening standards for new loans.
"If you can't get a mortgage, you can't buy a house," says David Wyss, an economist at Standard & Poor's in New York. "It's going to hurt. It's just a question of how much it's going to hurt."
Foreclosures by themselves won't dictate where the housing market goes. Supply and demand will be affected by a range of forces, including how the overall economy affects jobs and incomes, and the pace of home construction.
But as the spring selling season arrives, the housing market is struggling.
The numbers on new-home sales fell unexpectedly by 3.9 percent in February, according to numbers released by the US Census Bureau Monday.
Sales volume slid to the lowest level since June 2000. At the current pace of sales, about 8 month's worth of newly built homes are now available, the highest level since January 1991, during a recession and another housing downturn.
Inventories of previously owned homes have also been edging up, according to numbers released last Friday by the National Association of Realtors. Sales volume rose in February, but the unsold inventory climbed a bit faster, to a 6.7-month's supply.
The challenge of loan defaults appears small relative to the overall market in which some 7 million homes can change hands in a year. But in any market, changes at the margins often play an important role.
James O'Sullivan, an economist at the investment house UBS in New York, says that as banks tighten their lending standards, the hit could plausibly reach as high as 10 percent of home-sales volume.
"We believe the tightening of lending standards will not necessarily result in a renewed downtrend in home sales if other forces, such as slightly improved affordability, are moving in the other direction," he wrote in a March 16 analysis.
Concern about bad loans has spread recently, as subprime loanmakers have faltered. Analysts have been scrambling to assess the scope of the problem and its implications.
Few see the challenge as a train wreck scenario. "This will not break the economy," says Christopher Cagan, the director of research at First American CoreLogic, based in Santa Ana, Calif.
But it remains a serious problem, in part because of the rapid growth of nontraditional loans in recent years.
Many borrowers were given initially low "teaser" interest rates. As those reset upward, often within a year of origination, the borrowers frequently can't afford their monthly payment.
According to Dr. Cagan's research, that "payment shock" factor will make teaser loans the most likely to go into foreclosure.
For most homeowners, rising home values allow them to pay off their loans if and when they sell. But for those who bought near the peak, foreclosure looms when they can't sell for the price they paid.
Global Insight in Lexington, Mass., recently assessed the impact of foreclosures on housing supply and demand. Its forecast: About 194,000 people who would have qualified for a loan during the boom won't qualify now, because of tighter credit. And 279,000 housing units will come on the market in 2008 due to foreclosure, up from a predicted 201,000 this year.