Affordability concerns lead to higher DTIs, builder concessions

The difficulty consumers are having affording new homes is having a ripple effect throughout the system that has led to signs of some preliminary loosening in lender underwriting, and a growing number of builder price concessions.

Those are some of the key takeaways from a recent Moody's Investors Service report taking an in-depth look at North American housing finance and where it's headed.

"U.S. homebuying costs will remain elevated through 2024 at least, leading strapped individuals and families to cut spending on new homes and discretionary purchases and shift demand," Moody's said in the report, which includes contributions from around 20 analysts.

Elevated housing costs will likely keep pushing lenders and builders alike to keep doing what they can to bridge the affordability gap, even at their own expense, spurring the former to cautiously loosen underwriting and the latter to lower prices on new homes, the report said.

"New-home prices will drop 10%-15% in 2023 and 3%-5% in 2024 while input costs remain elevated, causing margins for homebuilders Moody's rates to decline 6-7% in 2023 from about 27% in 2022," Moody's projects.

Fortunately, builders generally have some give in their margins from the pandemic housing boom to absorb price concessions.

"From a financial strength perspective, the builders are actually doing OK," said Griselda Bisono, a vice president and senior analyst at Moody's, noting that normal margins prior to the pandemic were around 20%.

"They are offering a number of concessions, including base price reductions, but that has, for the most part, abated. What we're seeing more now are mortgage interest-rate buydowns, closing cost credits, or credit in the design center. Those are the three main ones, and a lot of what's offered will depend on what market you're in," she said.

When asked how this factors into the broader outlook for inventory, Bisono said Moody's has forecast that housing starts will be down about 18.5% this year relative to 2022.

"That number is below where we've seen it historically the past few years, but this is coming off of a very strong period," she said.

What the conditions in the new home market mean more broadly for supply and pricing overall is unclear as the amount of participation from the resale market is tough to gauge.

"This has been a very surprising year in terms of the lack of existing inventory," noted Jody Shenn, a senior analyst in Moody's structured finance group.

"If you look at forecasts of price predictions, most players have pulled in and some are actually now no longer expecting any future declines," Karandeep Bains, head of the residential mortgage-backed securities at Moody's, added. 

"In that push and pull of affordability versus the tight supply, we are still in the camp that there are additional price declines to come. But we've also sort of pulled in our peak to trough forecasts, like the rest of the market," Bains said.

Meanwhile, where underwriting is concerned, one sign that it is loosening lies in the fact that lenders have pushed debt-to-income ratios higher. They've risen beyond that seen during the mid-2000s bubble, an analysis of Urban Institute data in the report shows.

DTIs for owner-occupied purchase loans generally topped out at levels around 40% in the mid-aughts, but more recently they have risen to levels closer to 42%, according to the Moody's analysis.

"That said, borrowers' recorded incomes in such calculations continue to reflect overall much stronger vetting than the often-inflated 'stated' figures accepted in that past period," the Moody's analysts noted in the report.

That means the two periods aren't really comparable, said Shenn.

"It's a higher number now, but it is a different number, because the number back then was not as trustworthy," he said.

In contrast to the mid-2000s, when underwriting was extraordinarily loose, it's been relatively tight recently, and may have some give.

When asked what the increase in DTIs does portend for home loans, Bains said, "I wouldn't call it a performance stress, I would call it a risk factor in collateral performance.

"If you look at mortgage performance today,  it still remains extremely robust," he said.  "There's some weakness in 2022 relative to 2020 or 2021, but it's really marginal."

So while the higher DTIs do point to some weakening credit in originations, it's been limited to recent loans and thus outweighed by the ongoing run of historically strong, overall performance numbers by more conservatively underwritten, older mortgages, which have lower rates and were produced in higher-volume years.

"Reduced home purchase affordability will be negative for residential mortgage credit performance and exposed debt issuers, including insurers, lenders and securitizations," the analysts concluded. "However, effects will be very modest in comparison to the period after the last boom in property values, and mostly only material for newer loans."

That said, the higher DTIs do suggest an additional economic stress for consumers that the analysts plan to watch while also keeping an eye on other factors that influence the ability to repay, such as home prices and employment.

"Less extra income after your debt means you can't necessarily save for potential shocks," Shenn said.