As the housing market continues to show improved signs of strength, many first-time home buyers are failing to benefit from the broader recovery.
The Campbell/Inside Mortgage Finance HousingPulse Tracking Survey, released last week, found that first-time home buyers were purchasing only 34.7 percent of the homes sold in October. That's down from 37.1 percent in September, and is the lowest percentage ever recorded by the survey.
This decline surfaces as purchases of non-distressed homes—houses that are not in foreclosure—have increased dramatically in 2012. The report shows that the vast majority of the homes being sold are regular purchases—accounting for 64.7 percent of all houses sold in October, up from 55.7 percent in February. The increase is a sign of strength in the housing market, as fewer people are buying homes in foreclosure.
But according to the survey, first-time buyers are the only group that has not purchased more non-distressed properties in the last five months. Meanwhile, current homeowners are picking up an increasing number of properties, purchasing 54.4 percent of all homes in October, up from 50 percent in June.
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Thomas Popik, research director for Campbell Surveys, says these trends in the disparity of who is purchasing homes are due in part to increasingly tough mortgage standards by banks. But the real obstacle for first-time buyers is the Federal Housing Authority (FHA), according to Popik. At the depths of the housing crisis, the FHA loosened lending standards in an attempt to kick-start a housing recovery. Now that the recovery has begun, standards for FHA mortgages that require a 3.5 percent down payment are tightening.
"The basic problem is that about half of owner-occupant homebuyers rely on low down payment loans. FHA is now under significant financial pressure," Popik says. "They've tightened their underwriting, and weeded out a lot the lenders that have poor lending practices." He adds that, in the process, FHA has restrained access for first-time buyers who can't make the traditional 20 percent down payment.
Lack of access to mortgages for first-time buyers has broad consequences. Without these buyers, the housing recovery will be difficult to sustain. It also robs first-time buyers, many of whom are young (the National Association of Realtors estimates an average age of 31 for first-time buyers) of the opportunity to cash in on the recovery and build wealth.
Behind the FHA's tightening. As the housing market failed to gain traction following the explosion of the real estate bubble, the Obama administration decided to loosen standards for home loans—giving borrowers who would not qualify for a typical bank loan a chance to enter the housing market. At the same time, FHA extended lifelines to underwater homeowners, allowing them to refinance mortgages to keep their homes and avoid foreclosure.
These programs required FHA to take on large amounts of debt, Popik says: "FHA really picked up these low down payment loans in the second half of 2008 and 2009, even going into 2010 and 2011."
To service this debt, FHA had to rely on people who wouldn't have been able to qualify for a traditional loan and people who had homes that were underwater. As payments on these loans have slipped in recent years, FHA now finds itself $16.3 billion short in its insurance fund.
This has forced FHA to tighten lending standards, limiting loan options for many first-time buyers, says Tim Ralph, portfolio manager and chief operating officer at Biltmore Capital Advisors. FHA is now "looking for three years of steady income, understanding what's outside of your income in terms of debt, and you investment portfolio," Ralph says. "Rates might be at 2.75 percent, but that's not happening for someone with a 650 credit score who can't put 10 percent down. If there's a slight downturn in the housing market, this buyer would be immediately underwater."
According to Robert Simons, a professor of urban planning at Cleveland State University, FHA is now behaving like the big banks by avoiding borrowers who give the slightest hint that they might not be able to keep up with payments.
"Their taste for risk is complicated by how their overall portfolio is doing," Simons says, referring to the $16.3 billion shortfall. "If they have a lot of defaults, they will continue to have an unacceptable level of capital."
Changing attitudes toward housing. Simons says first-time buyers might be avoiding the housing market because of the hangover from the housing crisis. He says they are turned off by the unpredictability of the investment. "People are disillusioned. They don't see appreciation like they once did," he says. "There's a false hope of growing wealth in a house. People are being more selective about where they buy."
Simons also believes the culture of foreclosure that persisted throughout the crisis has negatively influenced attitudes toward the housing market. "People who went through it themselves, or know people who went through it, are definitely turned off. People who defaulted will not buy quickly," he says.