Editorial

With Recession On the Horizon, Is Mortgage Lending Becoming Riskier?

The financial chaos caused by the pandemic never really went away. Over the past two-and-a-half years, financial markets have recovered, but individuals have continued to struggle. Even those markets that have strengthened have done so in unpredictable ways, making it difficult to feel confident about any potential stability.

Now, a major recession seems to be on the horizon. There is no guarantee that this will occur, but if it does it may be much more difficult for America to recover. One of the reasons for this is the potential for another major housing crash.

Housing prices have been shooting up since 2020. This has been due mainly to a combination of low mortgage rates and low supply. It has also been easy for many people to get ARMs and interest-only loans, along with other mortgages that suit people who are looking to forestall the bigger payments. The market is finally starting to cool and does not look set to crash, but this could change, depending on decisions made by lenders.

There is a real possibility that mortgage lenders will soon start providing ever-riskier mortgages, leading us to a scenario similar to that in the early 2000s. Here’s why.

Falling demand

The housing market is cooling due to falling demand. Demand is falling due mainly to financial factors faced by every American. In 2022, we have seen inflation continue to rise, along with record-high gas prices due to the war in Ukraine. Inflation was already rising due to the low interest rates implemented by the Federal Reserve in response to the pandemic.

Rising interest rates were always going to be a reality as the world returned to normal and the Fed worked to slow down inflation. However, the many new factors contributing to inflation have caused the Fed to make bolder choices, raising interest rates at a faster and higher rate than planned.

This has led to mortgage rates increasing beyond the level they were at before the pandemic. Suddenly, homes which had gotten far more expensive in total value but had remained reasonable considering low APRs have become unaffordable. Demand is dropping, which is leading housing values to drop.

With this in mind, it is easy to see why lenders might start to panic.

Risky mortgages

After the Great Recession, mortgage lenders became a lot more discerning on the loans they were willing to provide. Their laxity had led to many homeowners who simply did not have the funds to continue paying their home loans. So many people defaulting on loans caused chaos.

In the years since, it has become significantly more difficult to get a mortgage. People who would otherwise have bought homes they couldn’t afford are instead renting indefinitely. Part of the reason housing values soared when interest rates were lowered was because people who otherwise could not afford a mortgage now had the capability.

The problem is that now that mortgage rates are high, fewer people than ever can afford mortgages, especially with the cost of living rising and wages still low in many industries. Not only are fewer people bothering to apply for mortgages they will not get, even those who are applying are being rejected.

This may change, and a change could lead to far more chaos than we are even anticipating.

The cost of panic

There will be many lenders who remain steadfast in their determination to only provide low-risk mortgages. However, panic has a way of spreading quickly in troubling financial times, and many lenders may make the decision to lower their standards. Their panic may lead to a glut of mortgages provided to individuals who they would otherwise have rejected out of hand.

If this was simply a case of approving a handful of risky mortgages, the impact would not be too big. Unfortunately, it is possible that lenders will make a push for high-risk borrowers to apply. People who had no intention of buying a home may be swayed by easy access to a mortgage they otherwise would never have been able to get.

Many new homeowners defaulting on their home loans could lead to a catastrophic shift in the housing market, triggering a collapse that rivals the one we saw in the 2000s. The care taken since then may go out of the window.

We may be ‘fortunate’ enough to see a financial crash before such mortgages can be handed out, especially since it looks like we’re hurtling towards trouble. As individuals, there is not much we can do either way. Those who are looking to buy a home with a mortgage that they otherwise would never get should think twice before making that decision.

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