Home loan changes cause buyers to forego starter homes

Buyers want the big home now, and home foreclosures often result

Buying a house has certainly changed over the years. In our parents’ day, they’d save money for a 20% down payment and buy a small home. If Dad’s salary grew and the house developed a bit of equity, perhaps the family could move into a larger home later. In the late 1960’s and early 1970’s a typical home might be a three bedroom, two bath home with some 1900 square feet of living space. Today’s average home might come in at 1000 square feet larger with a three car garage and a fourth bedroom.

And forget about the starter home; buyers want the bigger home now.

The days of starting small and working up are over. Most buyers, even young ones, want large houses from the get-go. And thanks to aggressive lending practices, that is often possible. Option ARM mortgages, interest-only mortgages, 80/20 piggyback loans and flexibility in closing costs all make it possible for young, first-time buyers to purchase more house than they either need or can afford. Adding to that is the problem of furnishing a large home, which often leads new homeowners to pile up additional credit card debt for furniture.

The result is a precarious financial situation that has more and more homeowners walking away from their homes. Foreclosure rates are up across the country, as more and more people realize that, caught up in the huge real estate boom of the last few years, they have bought more house than they can afford.

Their solution? Walk away.

It’s often easier to simply lock the doors and drive away than it is to face the debt, make the payments, or sell the home at a loss. More and more buyers are simply moving on and letting the mortgage companies deal with the problem. If it were a simple case of one or two homes nationwide, that would be a small issue, but in some parts of the country, home foreclosures are up more than 25% from a year ago, and that does not bode well for the lending industry. 

The more homes are returned to the lenders, the more likely that house values will fall. That will trickle down to hurt the lending industry even more. Lenders don’t like to get houses back; the process of liquidating a home is a time consuming and expensive one. More often than not, the houses are sold at a loss just to get rid of them. This, combined with the increasing number of foreclosures, can cause home prices and values of existing homes to rapidly decline in a region.

The lending industry and homeowners may be able to ride this out if no one panics. A slight and steady decline in home values wouldn’t necessarily be bad; home prices are already perceived as too high. A reduction in prices would simply make those homes available to other buyers who currently cannot afford them. A panic, however, could quickly cause a huge drop in prices that could lead to a nationwide recession, and no one wants that.