US housing market needs more than a rate cut

New York

THE US Federal Reserve is hoping that its latest interest-rate cut - announced last week - will help keep the economy safely at cruising altitude. But few expect it to provide much of a lift to the housing market.

Housing is one of the pathways by which Fed policy produces results. When the central bank cuts interest rates, it encourages people to buy houses (since mortgages are cheaper) and builders to ramp up construction (since demand is strong and borrowing is easier).

Those decisions then ripple through the economy, as people buy furniture, builders hire workers and brokers cash their commission checks.

But housing is not the engine it once was. The sector is a smaller part of the economy than before the financial crisis, and a smaller share of Americans are homeowners.

With rates already low, it isn't clear that a further cut by the Fed will do much for housing - if it lowers mortgage rates at all. Interest rates still matter for housing. The Fed's first two rate cuts this year helped stabilise the housing market, which had been heading for a major slump.

Last Wednesday, the Commerce Department said that construction added to gross domestic product in the third quarter after six quarters of contraction.

Lower rates could give another jolt to a refinancing boom that has injected billions of dollars into the economy in recent months.

But few economists expect the housing market to take off in response to this week's rate cut, because rates aren't what was holding back housing in the first place. Instead, they point to other factors.

Interest rates don't matter if no one will give you a loan in the first place. And a lot of would-be buyers are in that situation.

After the housing bubble burst over a decade ago, banks and other financial institutions became far more cautious in their lending, partly because of new federal rules meant to discourage risky loans.

No one wants a return of the bubble-era "liar loans," for which borrowers were allowed to state their income without verification. But some argue that the pendulum has swung too far the other way. The typical US homebuyer today has a FICO credit score of 741, compared with 700 before the housing crisis, according to data from the Urban Institute.

Hardly any buyers have a score below 650. Other measures of affordability likewise show that lending standards have loosened a bit in recent years but remain tighter than in the early 2000s, before the subprime lending boom.

Hard to find an affordable house to buy

"There are a lot of people that have the income to afford their payments, they could be responsible homeowners, but they may have a lower FICO score, they may have a smaller down payment, and that really holds them back," said Melissa Stegman, a lawyer at the Center for Responsible Lending, an advocacy group.

Glenn Kelman, chief executive of the online brokerage Redfin, said the combination of low interest rates and tight lending standards was exacerbating existing economic divides.

"Right now, money's really cheap, but you have to have a good credit score to be able to access it," he said. "It's been a bonanza for one group of people, the people who have always been able to get credit."

Housing prices have risen faster than wages in much of the country in recent years. And many cities, particularly on the coasts, are in the midst of a full-blown affordability crisis.

In cities like San Francisco, Seattle and Boston, the median price of a home listed for sale is well more than half a million dollars, according to the real estate site Zillow, and even starter homes can top US$300,000 - if there are any available.

At those prices, a modest dip in interest rates will hardly make a difference, said Susan Wachter, a professor of real estate at the University of Pennsylvania.

"This interest-rate decline will not do it - it will not turn these potential owners into buyers," she said. "Lower interest-rate costs are not effectively overcoming these affordability barriers."

The escalation in prices is a particular challenge for first-time homebuyers, who must struggle to come up with an ever-larger down payment.

While price appreciation has slowed somewhat over the past year in many markets, that is not true for entry-level homes, which are still seeing low inventories and rapid price growth.

"The few entry-level homes that are on the market are getting snapped up so quickly that it perpetuates the increasing home values in some of these markets," said Matt Speakman, an economist at Zillow.

Rates may not get much lower

Interest rates on conventional mortgages have fallen sharply since late last year, in part because of the Fed's rate cuts.

That has encouraged borrowing: Lenders extended US$700 billion in mortgage loans in the third quarter, the most since the financial crisis. Most of that surge came in refinancing, but there has been an increase in homebuying as well.

But with rates near record lows, it's unlikely that many would-be buyers are on the sidelines awaiting a further cut.

If they are waiting, they might be disappointed - many economists say financial markets have already "priced in" the latest rate cut.

"I'm sceptical that rate cuts are going to have any noticeable impact on housing in the short-run," said Ralph McLaughlin, deputy chief economist for CoreLogic, a real estate data provider.

There's another catch: Mortgage rates are tied not to short-term rates, which the Fed directly controls, but instead to long-term rates, which partly reflect market expectations about the economy's direction - long-term rates tend to rise when investors are more optimistic.

So if the Fed's policy achieves its broader aim, it can lead to higher mortgage rates. That has already begun to happen. Mortgage rates have edged upward since September as fears about an imminent recession eased.

Michael Fratantoni, chief economist of the Mortgage Bankers' Association, said he expected rates to continue to rise gradually. NYTIMES