BLOG VIEW: Because the private mortgage insurance industry plays a major role in helping first-time home buyers by lowering the down payment requirements, it has a unique view on the hurdles that first-time home buyers face.
Private mortgage insurers have seen a very strong rebound in the market for first homes since 2011. Improvements in macroeconomic conditions have helped, but equally important for this recovery has been the maintenance of high housing affordability – made possible by low interest rates and moderate income growth. Homes are highly affordable to first-time home buyers today and are expected to remain affordable in the near future, even as home prices appreciate and interest rates rise.
The Down Payment: A First-Time Home Buyer’s Main Hurdle
First-time home buyers make up an important segment of the housing market. According to the National Association of Realtors (NAR), first-time home buyers accounted for 32% of existing home sales in 2015.
First-time home buyers differ from other home buyers in one important aspect: down payment. A typical home buyer is a repeat buyer who already has home equity and other assets and can put at least 20% down. In contrast, a typical first-time home buyer does not have any home equity and has low levels of liquid assets.
The typical first-time home buyer Genworth served in the fourth quarter of 2015 had reported liquid assets of just over $18,000. To put this in perspective, a 20% down payment on a $200,000 home would have required $40,000. Although these borrowers may have other assets, such as retirement savings, a 20% down payment is still over twice the amount of reported liquid assets and would probably prevent many from getting a mortgage.
With private mortgage insurance, the typical down payment for first-time home buyers was just $12,000. It still takes two-thirds of a borrower’s reported liquid assets to meet the down payment requirement, but at least it is within reach and the borrower has some liquid assets left over for other needs.
For potential first-time home buyers, the inability to come up with a down payment can mean either spending more time as renters or living with friends or relatives. In the U.S., many surveys (for example, NAR’s Home Buyer and Seller Profile Survey) have shown that there is a strong preference to own rather than rent, so there is a large market for mortgages with a low down payment.
Private mortgage insurance makes low down payments possible by taking the first-loss position and preventing or reducing the loss faced by lenders and investors in the event of a default. In addition, private mortgage insurance helps lenders meet the extra credit risk protection requirement for loans sold to government-sponsored enterprises Fannie Mae and Freddie Mac. By reducing the down payment requirement and making homeownership possible sooner, mortgage insurance is a great example of Robert Shiller’s argument that finance can contribute to the good of society.
Based on data from Inside Mortgage Finance and NAR, we estimate that 71% of first-time home buyers purchased some form of mortgage insurance, with private mortgage insurance accounting for around 30% of the insured market. Data from Inside Mortgage Finance suggests that over half of all home purchase mortgages covered by private mortgage insurance went to first-time home buyers. The significant role private mortgage insurance plays in making homeownership possible for first-time buyers gives us a unique perspective on this important market segment.
Housing Affordability Today
Over the past four years, home prices have steadily moved up as the housing market recovered. In the fourth quarter, the typical first-time home buyer purchased a single-family home with a median price of $197,500. To purchase such a home, the typical mortgage had a loan balance of $185,250.
Interest rates have stayed low in the past few years, and that is a big help in keeping the monthly payment low. Total housing costs, including principal, interest, taxes and insurance, came to $1,323 a month in the fourth quarter – representing 24% of total family income for first-time home buyers insured by Genworth. This makes housing very affordable for first-time home buyers.
As experts in underwriting low down payment mortgage loans, we believe that housing affordability is normal when total housing costs are no more than 28% of family income. With housing costs at 24% of median family income, housing affordability for first-time home buyers is high, and that is one reason for the strong recovery the private mortgage insurance industry experienced in the first-time home buyer market.
How Far Is Housing Affordability From “Unaffordable”?
Though housing remains highly affordable for first-time home buyers, rising home prices and rising interest rates are likely to be trends in the next few years, and both are likely to drive housing affordability lower. So, it is appropriate to think about these as sensitivities of housing affordability.
The good news here is that housing affordability for first-time home buyers still has a way to go before becoming unaffordable. To get a two-point increase in housing cost burden as a percentage of a first-time home buyer’s median family income, the median home price must increase by 12% (or around $24,000) from the fourth quarter level, or the median 30-year conventional mortgage rate must increase by at least 100 basis points (or 1%) from the fourth quarter level to 5.2%. Combining these two changes will raise the housing cost burden above the median family income threshold of 28%. Any income growth will help offset the effect from higher home prices and higher interest rates. In other words, it will take big increases in both mortgage rates and home prices, while holding income flat, to get housing into unaffordable levels.
Private mortgage insurance plays an important role in helping families own their first homes when the down payment is the main hurdle. Strong housing affordability is an important part of the rebound we have seen since 2011, and we expect first homes to remain highly affordable in the near future.
Tian Liu is chief economist for Genworth’s U.S. Mortgage Insurance division.