Homebuyers: Proceed with caution

Article Highlights

  • Many of today's mortgages would now perform well under stressful conditions.

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  • In California, about 40% of recent purchase loans had a down payment of 5% or less.

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  • Nationally, nearly half of recent home purchase loan borrowers' monthly payments (mortgage and other debt) exceeds 38% of their pre-tax income.

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The article was first published April 23, 2014 in the Los Angeles Times: "A new housing bubble?" It has been updated to include new data on the Califronia housing market and it includes a new chart on down payments and debt-income ratios.

Even though the recent financial crisis is barely in the rearview mirror, risk is starting to build once again in both the U.S.mortgage and housing markets.

Contrary to the prevailing view that only borrowers with pristine credit records can get a mortgage these days, many risky loans are still being made. A new index published by the International Center on Housing Risk at the American Enterprise Institute measures this risk month by month, based on about three-quarters of all home purchase loans extended across the country. And the index clearly shows that many of today's mortgages would not perform well under stressful conditions. This conclusion holds for the nation as a whole and for nearly every state individually, California included.

Here's why. For the country as a whole, fully half of all the recent home purchase loans covered by the risk index had a down payment of 5% or less. In California, about 40% of recent purchase loans had such a small down payment ― not quite the national share but high nonetheless. With so little money down, these borrowers would be underwater with only a modest decline in housing prices. In addition, for nearly half of the recent home purchase loans nationally, borrowers' monthly payments on their mortgage and other debt exceeded 38% of their pre-tax income, the traditional threshold for acceptable payment burdens. In California, the share of recent borrowers with total payment burdens above this threshold is even greater, reflecting the high house prices here relative to income. Such borrowers could find it difficult to make their monthly payments if they came under even moderate economic stress such as a temporary layoff or a reduction in work hours.

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