Thanks to Lower Costs, Mortgage Rates First-Time Home Buyers Trickle Back Into Housing Market

For most of the year, high home prices helped drive many first-time home buyers out of the housing market. But good news may be on the way for these borrowers.

With prices falling in many areas, there are signs that mortgage applications are in demand once again.

The share of first-time home buyers dropped earlier this year to its lowest level since 1987, according to the National Association of Realtors. Currently, this group accounts for 36% of home purchases, down from 40% in the three previous years.

First-time buyers play a key role in the housing market.

They provide a source of new demand for homes, while also making it possible for owners of entry-level properties to trade up, creating a ripple effect that affects higher-priced sectors of the market. But declining affordability has made it difficult for first-time buyers to take out mortgages in many parts of the country, an important factor in the recent housing downturn.

For example: In Madison, rising interest rates and home prices knocked many first-time Wisconsin mortgage applicants out of the market early in the year, says Phil Sveum, broker-owner of Coldwell Banker Sveum Realtors.

However, in the past month, Mr. Sveum told the Real Estate Journal he has seen an increase in tenants looking to buy their first home. The recent drop in interest rates “has created some momentum for first-time buyers, not to write an offer today, but to start looking again and be serious about moving in January or February,” he says.

First-time buyers are particularly sensitive to rising housing costs, in part because they don’t have equity from an existing home they can tap as prices shoot higher. And lower incomes provide less of a cushion when monthly payments climb.

In a sign of just how hard it is for first-time buyers to come up with the cash needed to buy a home, 45% of first-time buyers bought their home with no money down mortgages, according to the recent National Association of Realtors survey, up from 43% a year earlier.

But recent figures have been encouraging for first-time buyers.

The National Association of Realtors reported that the median price of an existing home fell 3.5% in October from a year earlier, the largest decline since the group began collecting these data in the late 1960s. The average rate on a 30-year fixed-rate mortgage now stands at 6.16%, the lowest level since October 2005.

Yet affordability remains a problem for many would-be buyers.

In the second quarter, buyers had to stretch more than ever before in 25 of the top 50 markets, according to Bank of America analyst Daniel Oppenheim. Even with the recent price declines, he estimates that it would take a further 7% fall in home prices, combined with a 4% annual increase in nominal incomes, to bring affordability back in line with average levels over the past decade by 2008 - if interest rates remain stable.

In recent years, many first-time buyers had been able to stretch their dollars by taking out adjustable rate mortgages and so-called affordability home loans, which allowed them to lower their monthly payments or buy a home with little, if any, down payment.

But as short-term interest rates have climbed higher, the benefits of ARMs have declined.

At the same time, some first-time buyers have become more cautious. Sheila Doyle, an agent with Baird & Warner in Glenview, Ill., says that more of the first-time buyers she works with are getting their parents to help them with a down payment and fewer are financing 90% or 100% of the purchase price.

“I don’t see them doing the crazy financing that was so frequent last year,” she says.

New guidelines for nontraditional, bad credit mortgages, recently issued by federal banking regulators, could make it tougher for some first-time buyers to use these products. Some lenders are also beginning to tighten their standards as mortgage delinquencies rise.

Meanwhile, many would-be buyers are taking a wait-and-see approach. When home prices were soaring, many first-time buyers jumped to buy houses they could barely afford, believing they would be shut out of the market if they didn’t act quickly.

Now, with prices falling in many areas, “there’s no immediate need to buy, and so they kick the tires more,” says Frank Borges LLosa, owner of FranklyRealty.com, a brokerage in Arlington, Va.

Scott Steiner, a managing home mortgage broker of Help-U-Sell Lakeview Realty in Lake Elsinore, Calif., says he’s getting fewer calls and doing fewer showings for the properties he’s listing. But fliers describing the properties are being snapped up faster than ever before - a sign, he says, that many first-time buyers are taking their time and waiting for the market to stabilize before making a move.