The Risk of Zero-Rate Lending as the Fed Talks Recession
Bank of America recently announced a loan for low-income households that does not require buyers to provide a down payment or closing costs, and does not base the loan on a minimum FICO score. People’s first reaction was to wonder if it was 2008 again. Are we really making these kinds of loans and promoting home ownership again without understanding the risks?
Well, it’s not 2008, but this type of lending does come with risk – and it’s the risk that’s traditional among all late-economic cycle loans in America when the loan requires little or no down payment. Sure, this Bank of America loan doesn’t have the exotic loan debt structures that caused so much pain during the housing crisis years, but it’s good to understand what could happen.
First, to explain my logic here, I need to express what I believe housing is: “Housing is the cost of housing relative to your ability to carry debt. It is not an investment. »
Part of our housing dilemma is, how can you make something affordable when you’re promoting it as someone’s best investment? Since many people believe that housing is a creator of wealth – and we want more Americans to have more wealth – the government must ensure that demand remains high enough for this wealth product to grow.
The whole system should be designed to inflate the price over time. That’s what we do in America. The housing market is highly subsidized so that demand increases and every time the economy weakens rates go down and this has a disproportionate impact on the housing market.
When mortgage rates drop, the majority of homebuyers (including homeowners who must sell to buy another home) are mostly employed, so lower rates benefit them greatly and demand for housing increases. This can cause home prices to get out of control, especially when the total inventory is at historically low levels. That’s what happened here in the United States. We finally paid the price – pun intended – for not having enough product, with massive house price increases from 2020 to 2022.
The National Association of Realtors Total inventory data shows that historically we have between 2 to 2.5 million houses for sale, but in 2022 we have fallen as low as 870,000 in total inventory. I always like to add that active rosters were higher in the 1980s – and we have a lot more people now. So when you add up buyers, down buyers, first time home buyers, cash buyers and investors, it can get out of hand.
We can see a clear deviation in house price growth from 2020, when we hit historically low inventory levels. So if it seems like I was freaking out about house price growth and desperately wanting inventory to go up, you can see my logic. In the summer and fall of 2020, I was basically in “danger, danger, Will Robinson” mode as inventory channels crashed at the worst possible time for our country.
Now we’re talking about a housing reset, and the Federal Reserve is raising rates with a tone that even implies they realize they can create a job-loss recession! I just want to point this out: the Federal Reserve is actively saying that households are going to feel pain and some are making statements that they might not cut rates during a recession if inflation is high.
For the traditional homeowner who bought a home many years ago and saw their nested equity skyrocket, that’s not much of a problem. If they lose their job, they have a lot of equity in their home, and most likely their finances have improved over time.
It’s a plus of home ownership, a fixed cost of long-term debt as their salaries rise every year. As you can see below, we didn’t experience the mortgage boom like we saw during the housing bubble years. So not only do we have over 40% mortgage-free homes, but the nested homeowners’ equity is now almost unfair. Remember that the system is designed to keep house prices inflated.
I always emphasize how crucial it was to have the Bankruptcy Reform Acts of 2005 and the Qualified Mortgage Acts of 2010, which together allowed homeowners to have the best financial profiles in the history of our country. When we look at the credit data over the last 10 years it looks nothing like the stress we experienced from 2003 to 2008 which was economic expansion and jobs created before the recession job losses in 2008 .
Homeowners buy a home, have a fixed payment, and over the life of the loan, as their salary increases, their cash flow improves.
FICO scores look much better now than as the Great Financial Crisis approached. So you can see the advantage of having a fixed payment housing cost, while your salary increases. We no longer have 100% loans that have a large overhaul rate risk, so the full house payment can force someone to sell, even if two people are working full time and don’t have lost their job. We now have a much better housing ecosystem.
That said, the concern I have with Bank of America’s no-down payment loan will be the concern I always have with late-cycle lending in any economic expansion. If we’re going to provide 100% financing with no closing costs and the Federal Reserve is talking about needing a recession, then I think we need to make sure people realize the risk of this type of lending. I have to make this statement because my six recession flags are up.
Let’s assume all parties understand the risk of the Bank of America 100% loan and other low down payment loans as the Federal Reserve tries to raise the unemployment rate. In this case, no one can be blamed for the product, either the one offering the loan or the one taking it.
In theory, you should never lose your home unless you lose a job or experience a financial emergency. Your home is where you raise your family, and the mortgage payment you make each month should give you a good night’s sleep.
However, no matter how strong the loan, we cannot overlook business cycle risk, especially when Federal Reserve officials talk about the need to raise unemployment rates to fight inflation. .