Mortgage Applications Surge as Homebuyers Seek to Benefit from Tax Credit
By Dean Baker
October 7, 2009
Higher interest rates and the end of the tax credit imply lower future house prices.
The Mortgage Bankers Association (MBA) reported that its purchase mortgage applications index jumped 13.2 percent last week to its highest level since February. This is likely attributable to a last ditch effort by homebuyers to close on a house before the $8,000 first-time homebuyers tax credit is scheduled to expire at the end of November. Given the lead-time between contracting and closing (the credit depends on the date of closing), we are approaching the end of the period in which a contract can be expected to close in time to qualify for the credit.
Low interest rates were also a factor pushing demand last week. The interest rate on 30-year mortgages averaged 4.89 percent according to the MBA. This is the third consecutive week that it was below 5 percent. The low mortgage rates also led to a surge in applications for refinancing. This index was up 18.2 percent from the prior week.
With Congress debating a renewal of the first-time buyers credit, it is worth noting its likely impact on the market. According to several estimates, it will lead to close to 350,000 additional home purchases by the time it expires. It presumably also had a substantial impact on stabilizing house prices.
According the National Association of Realtors, 40 percent of buyers are now first-time buyers, most of whom are eligible for the credit. In principle these people would be willing to pay $8,000 more for a home than they would have been willing to pay without the credit. This is 4.7 percent of the median house price for an existing home. If just half of the credit was reflected in higher house prices, it would mean that the median house price is 2.4 percent higher than it would be in the absence of the credit. This, alone, would go far toward stabilizing house prices. Of course the extraordinarily low interest rates available at present are also a factor lifting house prices.
This raises the issue of what happens to house prices when interest rates return to normal and the credit eventually expires (even if the credit is extended beyond November, presumably Congress will not always support taxing the general population to give people $8,000 to buy a home). It is likely at that point that house prices will decline further, presumably completing the deflation of the bubble. This could mean that many of the people who buy homes in the current market are likely to sell them at a substantial loss (after adjusting for inflation). Temporarily propping up house prices, so that a new set of homebuyers can incur losses, is a policy of questionable merit.
The extension of the tax credit is likely to have limited impact in boosting sales in the future largely because it has been relatively successful in pulling demand forward. Most of the people who bought homes because of the credit would have otherwise bought homes in 2010 or even 2011. Because they bought a home this year, they will not be in the market in future years. Therefore, the pool of potential first-time homebuyers is much lower today than it was last February.
Whether or not the credit is extended, the outlook for the market in the near future is almost certain to darken. The number of mortgage delinquencies continues to rise. With the economy continuing to lose jobs and many homeowners having exhausted their savings and their unemployment benefits, there will certainly be more distressed sales in the future. In addition, it seems unlikely that interest rates will remain at the extraordinarily low levels that they have been at in recent months. We are approaching the end of the period in which the Fed has committed to buy mortgage-backed securities, so unless they extend their purchases, mortgage rates will almost certainly be rising in the next few months. In short, there are many factors suggesting that the housing market will weaken with more supply and weakened demand. There is really nothing pointing in the opposite direction.
Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.