Financing the Home Purchase

by Paul Bishop, Harika "Anna" Barlett and Danielle Hale, NAR Research

The 2008 National Association of REALTORS Profile of Home Buyers and Sellers was released in November.* The Association surveys home buyers and sellers annually to gather detailed information about the home buying and selling process. These surveys provide information on demographics, housing characteristics, the experience of consumers in the housing market, and the role that real estate professionals play in home sales transactions. In the November and December issues of Real Estate INSIGHTS, we looked at highlights from the profiles about home buyers and sellers. This month, we focus on home financing.

Financing the purchase of a home can be a significant challenge for some buyers. The recent turmoil in financial markets has definitely had an impact on the availability of mortgage credit for those consumers wanting to purchase a home.

But eventually credit will flow again. Recent trends in home financing can help real estate professionals be ready. Below we summarize information about financing the home purchase from July 2007 to June 2008 from the most recent NAR Profile of Home Buyers and Sellers.

Tighter underwriting standards have made financing the home purchase more challenging than it has been in previous year. In fact, compared to the previous survey in 2007, a smaller share of both first-time and repeat buyers report that they financed the entire purchase price of their home with a mortgage. Moreover, a significant percentage of buyers reported that they made some type of financial sacrifice in order to qualify for a mortgage and complete the sales transaction.

Financing the Home Purchase
Ninety-three percent of home buyers reported that they financed their home purchase with a mortgage. Among younger buyers, the percentage was 98 percent, decreasing somewhat for buyers between 45 and 64 years old. A significantly smaller share — two thirds — of buyers 65 and older financed their home with a mortgage, reflecting a significant share who used equity built up over a number of years allowing them to forgo use of a mortgage. Unmarried couple households rely on mortgages more often than other types of households. Single person repeatbuyer households were least likely to finance their home purchase with a mortgage.

Percent of Home Purchase that was Financed
One of the most significant changes in the characteristics of mortgage financing has been the sharp drop in the percentage of buyers who financed the entire purchase of their home. This no doubt reflects the tighter underwriting standards that many lenders implemented during the past year. In 2007, 29 percent of buyers reported that they financed their entire purchase with a mortgage compared with 23 percent in 2008. Among first-time buyers the share with 100 percent financing fell from 45 percent to 34 percent.

Downpayments
The median downpayment by first-time buyers was 4 percent, up from 2 percent in 2007; the number purchasing with no money down fell from 45 percent in 2007 to 34 percent in the current survey. Again, this likely reflects tightened lending standards. Indeed, by the close of the survey period (June 2008), no-downpayment loans all but disappeared.

Savings remains the major source of downpayment funds for the purchase of a home. As the share of buyers financing with no downpayment decreased, the share of buyers who relied on savings rose from 52 percent in 2007 to 56 percent in 2008. Half (51 percent) of repeat buyers used the proceeds from the sale of their previous home, down from 60 percent in 2007. Twenty-six percent of first-time buyers used a gift from a friend or relative, up from 22 percent in 2007.

Sources of downpayment vary across households of different types as well, although savings is the dominant source of downpayment for all types of households. Compared with other types of households, a greater share of unmarried couples and single male households relied on savings. Married couples depended on the proceeds of the sale of a previous home more often than other buyers.

Giving Up to Get
For some households, the purchase of a home and qualification for a mortgage requires some type of financial sacrifice. Buyers most often reported that they cut spending on luxury items(29 percent), entertainment (28 percent) or clothes (21 percent) in order to keep their debt lower to qualify for a loan. By a wide margin, first-time buyers more often reported cutting spending in these areas compared with repeat buyers. Still, 63 percent of repeat buyers and 41 percent of first-time buyers noted that they did not need to make any sacrifices.

Across different types of households, single female and unmarried couple buyers more often reported making some type of sacrifice in order to qualify to purchase a home. Nearly one-third of single female buyers cut spending on luxury items and entertainment; 29 percent of single female buyers also reported cutting spending on clothes. Among unmarried couple buyers, four in ten cut spending on luxury items or entertainment, and three in ten reduced expenditures on clothing.

Mortgage Challenges
Among recent home buyers, 7 percent noted that the mortgage application and approval process was much more difficult than anticipated with an additional 20 percent noting that it was somewhat more difficult than in recent years. It should be noted, however, that these views belong to those home buyers who successfully completed a home purchase transaction and consequently do not include an assessment of the difficulty of the process by potential buyers who were unable or unwilling to complete the purchase of a home.

One in ten unmarried couples who purchased a home described the mortgage process as much more difficult than anticipated. Although there was some variation across other types ofhouseholds, most did not consider the process difficult.

Of course, some households who wanted to obtain a mortgage in order to purchase a home faced additional hurdles. Among home buyers who successfully financed the purchase of their home, 5 percent reported that their mortgage application was rejected by one lender, with an additional 3 percent experiencing a rejection by two or more lenders.

Types of Mortgage Loans
Nine of ten home buyers reported that they secured a fixed-rate mortgage to finance their home purchase. That is an increase from the 81 percent who financed their home via a fixed-rate mortgage in 2007. Just 4 percent of buyers indicated that the interest rate on their mortgage was fixed for an initial period before adjusting, down from 10 percent in 2007.

Buying a Home: a Good Investment?
The majority of home buyers still believe that their home purchase will be a good investment. Eighty-seven percent of home buyers considered their purchase a good financial investment. Nearly half (47 percent) of buyers believe that their home is a better investment than stocks,with an additional 31 percent viewing it as equivalent to stocks. There is little difference in the perception of first-time or repeat buyers.

There was, however, disagreement agreement about the investment value of their home purchase, depending on the type of home buyer household. Single male buyers were somewhat less likely to consider their purchase a better investment than stocks while single female buyers and unmarried couples were the most optimistic.

Looking Ahead
The current economic recession, job losses, and more restricted access to mortgage capital will no doubt have an impact on home buying activity in early 2009. But with mortgage rates around 5 percent and an unprecedented inventory of homes - both new and existing - there are many opportunities for homeownership for buyers with solid credit. Government programs, including the home buyer tax credit, higher FHA loan limits, and the eventual flow of mortgage capital from banks and lenders (as a result of the Troubled Asset Relief Program) will also help home buyers and homeowners. A new economic stimulus package - if it includes significant housing-stimulus provisions — should also help enable consumers to become homeowners and purchase a piece of the American Dream.

*NAR mailed an eight-page questionnaire in August 2008 to a national sample of 133,000 home buyers and sellers who purchased their homes between July 2007 and June 2008, according to county records. It generated 10,053 usable responses; the adjusted response rate was 7.9 percent. All information is characteristic of the 12-month period ending in June 2008 with the exception of income data, which are for 2007. Because of rounding and omissions for space, percentage distributions for some findings may not add up to 100 percent.