First-time homebuyers are lining up to transform the mortgage industry
The mortgage origination market is in the middle of a dramatic transition in customer mix. This transition is driven by two powerful forces — pent-up demand accumulated over the past 10 years and the influx of a large group of new homebuyers. This transition has already sent the pendulum swinging back toward a homebuyer market dominated by first-time homebuyers, a trend that will continue for years to come. This transformation will change the product mix in the mortgage origination market from high- to low-downpayment products and present an opportunity for originators to establish lifelong relationships with a new generation of borrowers.
Before delving into recent market developments, however, let’s look at some historical trends for context. First-time homebuyers represent a transition in housing demand from rent to own, making them pivotal to the purchase market. They also provide momentum for the rest of the housing market by releasing home equity to homeowners to buy their next home.
First-time homebuyers purchased an average of 1.8 million single-family homes per year between 1994 and 2016. Some 35 percent of single-family homes sold are bought by first-time homebuyers. First-time homebuyers are even more prevalent when looking at the purchase-mortgage market because of their greater reliance on mortgage financing. Historically, 45 percent of new purchase loans go to first-time homebuyers.
Although first-time and repeat homebuyers face the same macro-environmental factors, such as interest rates, their purchase decisions are based on different economic and demographic drivers. The delay in first-time homebuying in the aftermath of the housing crisis and the size of the population now reaching peak household-formation age are two of the main drivers for the strong performance of the first-time homebuyer market over the past three years.
The housing crisis left a large deficit in the first-time homebuyer market. Since 2007, first-time homebuyers averaged just 1.5 million a year, compared to the 1.8 million annually pre-crisis. This means that 3 million first-time homebuyers went missing from the housing market over the past 10 years. Not only were the years between 2007 and 2015 below historical averages, they were the nine worst years in the first-time homebuyer market in the past 24 years.
The homeownership rate among younger households tells a similar story. Households headed by people under the age of 35 crashed 7 points, from 42 percent in 2007 to 35 percent in 2016, leaving many would-be first-time homebuyers on the sidelines of the housing market. Many of these buyers will come back to the housing market, however, representing a large source of future growth.
In fact, demographics for the first-time homebuyer market have become more favorable over the past five years as more people move into peak household-formation age. Birth cohort sizes — a proxy for population size — of potential early first-time home-buyers (people 25 to 34 years old), increased from 36.4 million to 38.9 million between 2012 and 2017, according to data from the U.S. National Center for Health Statistics.
That favorable trend should continue over the next five years, as the cohort size of potential early first-time homebuyers is expected to increase to 39.9 million by 2022. During that same time, growth also will rotate from early first-time homebuyers to late first-time home-buyers (people 35 to 44 years old). That group is expected to increase from 33.7 million in 2017 to 36.4 million in 2022.
Analysis suggests the drivers for an up-swing in first-time homebuyers should last for the next few years, and recent data supports this view. Of the 1.3 million-unit increase in single-family home sales between 2011 and 2016, 828,000 units, or 63 percent, were purchased by first-time homebuyers. Over the past two years, first-time homebuyers accounted for 85 percent of the growth in home sales.
In the purchase-mortgage market, the mix of first-time home-buyers is only exceeded by levels in 2009 and 2010, which were elevated from the first-time homebuyer tax credit and a weak housing market. Based on data from the first half of this year, 2.2 million first-time homebuyers are expected to purchase a home this year, making 2017 one of the top three years for the first-time homebuyer market.
The biggest challenge created by the growing first-time homebuyer market has been the tightening in the housing market. The available inventory of previously owned homes was down 8 percent year over year during the second quarter of 2017, and the supply of existing homes for sale has dropped to 4.2 months as of this past August, compared to 4.8 months a year earlier.
In an expanding first-time homebuyer market, the rate of purchase-mortgage originations will grow faster than the growth rate for cash home sales.
Many of the homes absorbed by first-time homebuyers had been vacant. This is one way the housing market adjusts to insufficient supply — by using the available stock of housing units more efficiently. Compared to the same period last year, the number of vacant housing units for sale was down by 100,000 this past second quarter. This reduced vacancy rates to 1.5 percent, the lowest level since 1994.
One would expect a bigger increase in new construction from the homebuilding industry to alleviate this tightness, but that was not the case until recently. Between 2012 and 2016, there was hardly any increase in homebuilding activity at the “low” end of the market, or new homes priced under $250,000.
Growth in the first-time homebuyer market is beginning to catch the attention of the homebuilding industry. New single-family homes priced between $200,000 and $250,000 —the segment popular with first-time homebuyers — was the fastest-growing segment this year, with homebuilders reporting year-over-year growth of 33 percent. The volume increase remained modest at 13,000 units for the first half of the year, however. For the full year, it is likely that homebuilders will add 20,000 to 30,000 units in that price range. Given that sales to first-time homebuyers grew by more than 100,000 units in the first half of 2017 alone, the market should remain undersupplied in the near term. The increase in low-end new construction should continue in years to come and become an important source of growth for the homebuilding industry.
The tighter housing market also has put upward pressure on home-price appreciation, which has accelerated since 2014. During this past second quarter, home prices were up 6.6 percent from a year earlier. Even with homebuilders beginning to increase production at the low end of the market, it has been insufficient to ease the pressure on inventory and moderate home-price growth.
Strong first-time homebuyer demand and insufficient new construction means home-price growth is unlikely to slow down in 2017 or 2018. This is at odds with the consensus view that deteriorating affordability will cool the market, but the growing first-time homebuyer market should overcome the cooling impact of rising home prices.
In fact, the rapid increase in the number of first-time homebuyers over the past three years has revived the momentum in homeownership among younger households. During this past second quarter, homeownership rates for households headed by people under the age of 35 increased by 1.2 percentage points from a year ago.
This momentum is generating strong demand for new and existing affordable single-family homes, as well as for mortgage credit, which is normalizing the housing market away from cash sales. In an expanding first-time homebuyer market, the rate of purchase-mortgage originations will grow faster than the growth rate for cash home sales because first-time homebuyers are more dependent on mortgage credit.
The return of first-time home-buyers also will expand the footprint of low-downpayment mortgages. Close to 80 percent of first-time homebuyers use low-downpayment mortgages instead of putting 20 percent down. Thus, faster growth in the first-time homebuyer market will translate into faster growth in low-downpayment mortgages.
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The expansion in the first-time homebuyer market is expected to bring challenges for the mortgage industry. Potential first-time homebuyers are less familiar with the mortgage application and homebuying process, and not everyone is truly ready for the obligations of homeownership. The industry will need to be vigilant against a return of risky products.
The action item for originators today is to make sure they understand first-time homebuyers and their needs. These young borrowers present an opportunity for originators to establish lifelong financial relationships with clients who will need other products and services later in their life cycle. It is important, therefore, to establish a close relationship with first-time homebuyers.
Original article featured in the Scotsman Guide.