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Household Debt Inches Higher

Household debt began to shrink in early 2009 and dropped by nearly $1.4 trillion before bottoming out in mid-2013. According to the most recent data, consumer debt has increased in back–to-back quarters for the first time since early 2008. The Federal Reserve Bank of New York reports that household debt has grown from $11.28 trillion in the third quarter of 2013 to $11.52 trillion in the fourth quarter.

 In the fourth quarter of 2013, 75 percent of household debt consisted of obligations secured by real estate (mortgages and home equity loans), 6 percent of credit card debt, 7.5 percent auto loans, and 9.3 percent student loans. Mortgages were responsible for 63 percent of the increase in household debt, followed by student and auto loans. However, going forward, mortgage lending may face stronger headwinds if mortgage rates continue to rise.

Figure 1: Composition of Total Debt

Households’ net worth has been increasing since the end of 2009 and has averaged 7.4 percent year-over-year growth since then. There are two reasons that household net worth can increase: liabilities can decrease or assets can increase. In the current case, household net worth is increasing because households' financial assets are increasing faster than their liabilities. Households' total real estate holdings increased 11.5 percent from the fourth quarter of 2012 to the fourth quarter of 2013. Meanwhile, year-over-year mortgage growth was just 0.2 percent.

According to the National Association of Realtors (NAR), the number of existing single-family home sales decreased from 4.36 million in March of last year to 4.04 million in March of this year. In a quarterly survey of senior loan officers, a net 26 percent of respondents reported that demand for prime mortgages is down (that is, the reports of decline exceed the reports of increase by 26 percentage points). A net 16 percent reported a decline in demand for nontraditional mortgages, while a net 14 percent reported a decline for subprime mortgages. As recently as the third quarter of 2013, a net 49 percent and 25 percent of loan officers had been reporting stronger demand for prime and subprime mortgages, respectively.

Figure 2: Existing Single-Family Home Sales
Figure 3: Changes in Demand for Residential Mortgage Loans: Net Percentage Reporting Stronger Demand

In the same survey, senior loan officers are asked if approval standards are tightening, loosening, or remaining unchanged. Leading up to and during the recession, standards tightened significantly, peaking at a net 74 percent of respondents reporting that their banks were tightening approval standards for prime mortgages in the third quarter of 2008, and 90 percent and 100 percent reporting tightening of standards for the nontraditional and subprime products. For the last two years, most loan officers have reported no change in their prime and nontraditional mortgage lending standards, with a bias toward easing for prime borrowers. While the standards remain unchanged for prime borrowers, there has been a significant jump in tightening for nontraditional and subprime borrowers in the second quarter.

Figure 4: Changes in Standards for Residential Mortgage Loans: Net Percentage Reporting Tightening Standards

In addition to creditors tightening their lending standards, the 30-year conventional mortgage rate has gone up since its post-recession low of 3.35 percent in December 2012. Currently, the 30-year conventional mortgage rate lies at around 4.3 percent, which is still low compared to historical values.

Figure 5: 30-Year Conventional Mortgage Rate

Even though mortgage interest rates and home values are rising, homes are currently more affordable than they were during the 1990s and early 2000s, which could encourage further growth in home sales. The NAR’s Housing Affordability Index was 175.7 in February 2014. An index value greater than 100 means that a family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment.

Figure 6: Home Affordability
Figure 7: FHFA Housing Price Index

Do these data points bode continued improvement in the real estate market? The data present a mixed picture. On one hand, houses are still very affordable despite rising mortgage rates and home prices. On the other hand, lenders and consumers seem to be highly sensitive to perceived risks in the market, as evidenced by the tightening credit standards and the sharp decline in mortgage demand following a mild increase in mortgage rates.

Going forward, the uncertainty over the future pace of the housing recovery may cap the rate of increase in home values and the pace of construction activity. These may be interpreted as headwinds for economic growth. But from a financial stability point of view, the apparent sensitivity to the inherent risks of real estate transactions may be preferable to the nonchalant approach to real estate investments in years past.

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