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The Triple Threat To Real Estate

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Read this article about the triple threat to real estate.

Investors deem mortgage backed assets to be safe, or at least some of the safest income products currently available and because mortgage backed assets typically have higher yields than government issued bonds the demand is soaring. So here is the triple threat:

One -- Credit Quality: The credit quality of new mortgages in the US has declined dramatically in recent months. The value of subprime loans included in mortgage backed assets doubled in the past two years and according to the Wall Street Journal, loans without full documentation of the borrower’s income and assets (the most risky type of loan) accounted for 70% of mortgage securities rated by Standards and Poor’s in the first half of this year.

Two -- Rising Mortgage Rates: As the credit quality continues to decline investors might start asking for higher returns to compensate for the increase in risk and that would push up mortgage interest rates. But the surge in variable rate mortgages means that the US real estate market is now very sensitive to a rise in mortgage rates.

Three -- Reduced Investor Demand: If mortgage rates rise, borrowers may find that they are unable to make their mortgage payments on variable rate loans. Higher mortgage rates will very likely also mean lower real estate prices, and so there is a reasonable probability that borrowers in trouble will not be able to sell their homes for enough to cover their mortgages. Real estate taxes and broker commissions mean that even if real estate prices do not decline, a seller needs to sell his home for about 10% more than what he purchased it for just to break even.

The prevalence of homeowners who have mortgages equal to, or exceeding 100% of the current market value of their homes is where the problem lies. These are typically also the same borrowers who have adjustable rate or interest only mortgages. When they cannot pay their mortgages any longer and are unable to sell their homes for more than their mortgage debt they will merely hand the keys to banks.

Defaults on mortgages could cause a downgrade in the credit rating of mortgage backed assets and reduce investor demand for such products while simultaneously increasing the interest rates investors require as compensation for the increased risk. As investor demand for mortgage backed assets wanes the banks will tighten the credit quality and write less mortgages. That means less eligible buyers, which means lower real estate prices and lower real estate prices will cause even more defaults by stuck homeowners who are unable to sell their homes to cover their mortgages. And, higher interest rates on mortgage backed assets will translate directly to higher mortgage rates.

A slowdown in the real estate market can have dire consequences for the US economy and the US dollar. The question is only how soon it will happen.

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?

      • down 5% +
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