Editor’s note: This article appeared in US News & World Report on May 12, 2016.
While rising income inequality has become the bete noire of the left today, surprisingly, there has been little outrage about misguided and short-sighted government housing policies which have increased the divide between the owners of capital (homeowners) and the rest. Affordability is a well-known concern today, yet the inherent inequity of a government-sponsored system that feasts on debt is much less understood. So let’s connect the dots.
Over the past four years, house prices have risen by over 30 percent, the reason being massive demand, fueled by low interest rates; looser underwriting, especially from the Federal Housing Administration; and a severely limited supply of dwellings. In such a market, the gap between the haves and have-nots is widening. The beneficiaries of rapid price appreciation relative to inflation or income growth are repeat buyers, whose assets have appreciated and can be reinvested as equity in their next home. The ones left behind are lower-income entry-level buyers, whose savings translate into an ever smaller down payment in percentage terms as prices rise. These buyers thus have a smaller cushion against a downturn in house prices, which raises their risk of default. Many first-time buyers face a stark choice: either take on greater leverage to finance their purchase or be priced out of the market.
Stimulating even more demand for houses through affordability measures or laxer lending standards, as the National Association of Realtors is always proposing, is sheer folly: Not only will the additional demand for homes result in even higher house prices, thereby further exacerbating the growing divide in the market, but it could also fuel the next housing bubble, exposing the U.S. economy and U.S. taxpayer to another potentially massive downturn when that bubble bursts.
The most recent example of the perverse effects of the administration’s affordable housing policies during a seller’s market involves the FHA’s mortgage insurance premium cut of January 2015. Intending to help low- and middle-income first-time buyers achieve the American dream of homeownership, the FHA reduced the annual mortgage insurance premium by 0.5 percentage points, which amounts to an equivalent cut in the interest rate. Many borrowers were tempted by the FHA loans which provided more buying power. Consequently, over the coming year, FHA-financed houses experienced faster price appreciation compared to houses financed with loans guaranteed by Fannie Mae, Freddie Mac or the Department of Veterans Affairs loans, for which policy did not change. Coincidence? I don’t think so.
In addition, the government, through burdensome zoning laws and regulations is preventing construction companies from providing more entry-level homes. Although builders are able to absorb some of the regulation costs when selling luxury homes with wider profit margins, they can’t do it with tighter margins in lower end homes. Again, those most adversely affected by such policies are lower-income and increasingly minority, first-time home buyers.
Despite these obstacles, supported by an improving job market and increasing leverage, first-time buyers have been flocking into the market, even as home prices continue to boom. They now account for 52 percent of all buyers. (The AEI First-time Buyer Mortgage Share Index is based on a near-census of loans guaranteed by federal agencies.) But as more entry-level buyers chase a limited supply of homes, entry-level prices have been rising rapidly. Over the last year alone, the median home price for first-time buyers rose 8.5 percent, compared with just 2.5 percent for repeat buyers. The only way that first-time buyers can survive in this environment is by taking on even more debt. This echo of the previous housing crash is again evident in today’s market.
So what should be done to break this vicious cycle? Repealing zoning laws and regulations will take time and run into fierce opposition from NIMBY communities and industry groups such as the National Association of Realtors, who all benefit from higher prices. A more immediate solution exists in the form of the Wealth Building Home Loan, which offers an alternative for first-time buyers. Instead of the standard 30-year fixed rate mortgage, the WBHL is based on a 15- or 20-year amortization schedule. This enables borrowers to build a larger buffer against default through faster equity accumulation without sacrificing any buying power relative to a 30-year FHA loan. The Wealth Building Home Loan also requires little or no down payment. A growing number of banks are offering the loan, and government support for the loan would speed its market penetration.
When connecting the dots, current housing policies amount to nothing less than a government-sponsored wealth transfer from the poor to the rich. It is time for a complete U-turn, away from a system that chokes entry-level buyers and prices others completely out of the market. Americans deserve a system based on equity creation and fairness that will enable everyone to achieve the American dream of homeownership.
Tobias Peter is a research analyst at the American Enterprise Institute’s International Center on Housing Risk.