Some cycles are just hard to figure out when and where they start and when and where they end. So let’s look at the housing cycle. I’ve always said, if you follow housing, you follow the economy. As a matter of fact, in a December 13, 2010 Wall Street Journal article, Doug Duncan, the chief economist at Fannie Mae, stated that home purchases in the first year of all economic  recoveries accounted for a one percent increase in the growth rate of the economy.

To that point, the $8,000 tax credit to first time home buyers expired earlier this year. Sales of exiting and new homes plummeted 25% in October from a year ago when the credit was in effect. 25%!

What is perplexing is that home purchases would be increasing due to the fact we are currently seeing the lowest mortgage rates in 60 years, with the average 30-year fixed rate at 4.21% in October. The problem is that lenders are tightening their standards and aren’t lending as freely. It was the loose standards of the past decade that got housing, and by default, (no pun intended) the economy into the problem it is in. Does that sound familiar? (You follow housing and you follow the economy.) 

Yes, we need to lend, but not to those who cannot afford a mortgage. When a bank loans money to a home buyer, they usually sell that loan to one of the government entities: Freddie Mac, Fannie Mae or the Federal Housing Administration. However, these entities have had heavy losses during this downturn, so they are reducing their risks. One way to reduce their risk is to require the banks to buy back non-performing loans, thereby putting the pressure back on banks to make sure borrowers are able to pay, which causes the banks to restrict their lending.

Banks are now making borrowers prove income (what a concept) for the last two years before the loan. This is not an easy thing to do in this economy. One of the few ways many have found to make a living these days is being self employed or being a consultant. As the article mentioned, these people take all kinds of deductions to reduce their income reported to the IRS, but that’s what the bank sees, and, of course, the lower your income, the less likely to get a loan because you’re less likely to be able to repay it. Another horrifying thought that was brought up in the article: if you’ve been unemployed for any period of time, this could be damaging if you’re applying for a loan.

So now we know why banks aren’t lending. However, the economy probably won’t pick up until housing stabilizes. We’ll see housing stabilize when there are less foreclosures entering the market and home prices stop falling. Then, lenders will be more likely to lend because the price of homes will be less likely to drop thereby making loans less risky. After that, the next step is to qualify buyers.

What’s happening is that many qualified buyers will be shut out of the market. The best way to qualify for a loan is to make a large down payment. Something to consider: do you have enough to make a 20% down payment on the home of your dreams? What are you doing in order to get to that point?