Perspectives : Markets & Economy | July 14, 2023

Well-positioned borrowers could support U.S. housing

Read time: 4 minutes

New Vanguard research identifies three drivers likely to support the U.S. housing market. This last of three articles highlights one of the drivers: healthy borrower fundamentals. “In this economic cycle, we expect housing to become a stabilizing force rather than a further drag as in past cycles,” said Josh Hirt, a Vanguard senior economist and part of the team conducting the research. “The undersupply of homes, supportive demographic trends, and healthy borrower fundamentals are key structural areas of support for the market ahead.”

Because the housing market is highly interest-rate-sensitive, the Federal Reserve’s hiking cycle has had a cooling effect. “It has raised concerns we could see something like what happened in the wake of the subprime mortgage crisis, when foreclosures flooded the market, intensifying the decline in home prices,” Hirt said. “But this is a very different housing market from the previous one, as borrower health overall is in a much better place.”

In periods of rapid home-price declines like we saw after the subprime crisis in 2007, homeowners can find themselves owing more than their home is worth. By 2011, more than a quarter of all U.S. mortgage holders were underwater. Such mortgage holders are much more likely to default, resulting in foreclosures that then add to supply and put downward pressure on prices. Lax lending practices and greater reliance on variable-rate mortgages at that time also made it tough for some homeowners to keep making their payments when interest rates rose.

“Forced supply coming onto the market is much less likely in this housing downturn,” said Konstantin Nikolaev, a Vanguard high-yield fixed income credit analyst on the team covering building materials. “Mortgage companies have been holding borrowers to much higher standards since the subprime crisis. And fixed-rate loans, which keep a homeowner’s mortgage payments from climbing even when interest rates rise, are much more prevalent today. Currently only 2% of homeowners owe more than their home is worth.”

The chart shows our projections of how home-price declines could affect supply. Even if prices fell by 20%, we would expect to see supply—the number of homes for sale as a percentage of U.S. households—rise to only about 1.9%, well below the peak during the subprime crisis of about 3.3% and the preceding 10-year average of about 2.4%.

“Our base case is for a year-on-year decline of 5% in home prices by the second half of 2023,” Nikolaev said. “That would add just 0.4 percentage points to the current level of homes for sale and would still be a full percentage point below the pre-subprime-crisis average.”

The risk of a supply shock is low even if home prices drop significantly

Notes: Our projections assume an instantaneous foreclosure supply shock, with cumulative total foreclosures being brought to market immediately.

Sources: Vanguard, using data from the U.S. Census Bureau, CoreLogic, and Bloomberg.

What solid borrower fundamentals could mean for the housing market

Housing affordability has been dented by the rise in mortgage rates—they’ve roughly doubled over the past year. But the equity cushion that the vast majority of homeowners have, the more stringent standards they were held to for obtaining a mortgage, and the more favorable financing terms they were given make a supply shock from foreclosures unlikely.

In fact, homeowners’ financial health—along with an undersupply of homes and supportive demographic trends—should put housing on the path to becoming an economic stabilizer, with negative contributions to GDP since mid-2021 turning positive by 2024.

Josh Hirt, CFA
Vanguard Senior U.S. Economist

Ian Kresnak, CFA
Vanguard Investment Strategy Analyst

Konstantin Nikolaev, CFA
Vanguard Fixed Income Credit Analyst

Peter Maguire, CFA
Vanguard Senior High-Yield Fixed Income Credit Analyst