Although the local housing market has not been affected, news related to mortgages and housing has been in the headlines for several months.
The housing industry is an important part of our economy. It creates thousands of jobs in the OKC area and across the country. An expanding construction business increases the number of skilled and unskilled jobs, from the architects who design the homes to the day laborers, carpet layers, and interior designers who build and finish them. Income from those jobs buys goods and services in our communities, creating even more jobs.
When the housing market declines, the reverse tends to happen. As jobs disappear, so does the income—making it difficult for people to pay their bills and make purchases.
In economics, we call this interdependence, which simply means that we are all inter-connected; what affects one person tends to affect another.
The downturn in today’s housing market began with people buying more house than they could afford by using creative financing methods such as adjustable rate mortgages. Commonly called ARMs, these loans allow borrowers to make reduced house payments for the first few years they own a home. The rates gradually adjust upward, based on a variety of schedules and factors.
The theory is that a homeowner’s income will increase at the same rate, allowing them to keep pace with the increase in payments. However, payments often escalate faster than income, or faster than borrowers can afford. Homeowners may get behind in their payments or start relying more on credit. Either way, they cannot sustain their lifestyle indefinitely. Eventually, they must decide what to do: sell the house or walk away through foreclosure.
The problem is compounded if others are in the same situation. If too many real estate signs pop up, prices tend to flatten. Potential buyers have a lot of choices, so owners must reduce the price to sell their house. The selling price may even drop below the amount owed, creating even more financial problems.
The impact of many homes coming on the market at the same time is compounded by growing fears among lenders that too many people are foreclosing on their loans, no longer meeting their financial obligation. If lenders lose money, they tend to tighten the lending requirements in hopes of finding potential borrowers who are a better risk. Tightening credit requirements means fewer potential buyers are approved to borrow money, resulting in fewer potential buyers. With fewer buyers, there is increased pressure to drop the sales price of those houses on the market.
The American Dream becomes the American Nightmare with homeowners who cannot make their payments, lenders who are foreclosing on more houses, and more houses for sale. These factors combined drastically drop the price of the owner’s investment.
What are some of the steps you can take to reduce the potential of this happening to you?
- Spend less on housing than you can afford to spend. Just because you qualify for a large loan does not mean you have to (or should) borrow that much.
- Factor in all other payments. Buying a home generally includes neighborhood association fees, utilities, taxes, insurance, maintenance, and other potential costs.
- Buy in stable neighborhoods. Neighborhoods attracting a large number of first-time homebuyers or with rapid turnover may be more susceptible to foreclosures.
- Notify your lender immediately if you have a problem with payments. Once you start missing payments, it becomes more difficult to get caught up or to resolve the problem with your lender.
- Control debt. Create a budget that you can live with—and follow it. Avoiding the temptation to overspend will help ensure you have sufficient funds for your house payment.
Sue Lynn Sasser, PhD, is an associate professor of economics at the University of Central Oklahoma.