Vacation Homes & Leverage

Haven’t We Seen This Story Of Low Interest Rates & Rising Prices Before?

Since the start of the Covid pandemic, people have sought out more square footage. The high schools of city living — usually justified by better access to restaurants, schools, and work — are now seen as frivolous, considering all 3 are closed or at extremely limited capacity.

Unrest in major cities in the Spring of 2020 accelerated a trend that was likely inevitable in an environment of work-from-home potentially persisting indefinitely and incredibly low, long-term interest rates: people are leaving cities. And if they aren’t leaving cities, they’re at least purchasing vacation homes.

That’s why since the pandemic outbreak, vacation home purchases have sky-rocketed. Now for many, this might sound like the beginnings of a housing bubble, fueled by low interest rates. For others, it reflects a lifestyle shift in the way business is conducted.

The big question is who’s right. Because a cultural shift presents a buying opportunity; a bubble? Well that leaves regulators nervous.

What’s New?

As the pandemic drove an uptick in vacation home purchases, regulators took notice. The number of buyers who locked in mortgage rates for second homes in February was up 93% year over year, eclipsing the 32% growth over the same period for primary residences. That wasn’t well received by Fannie Mae and Freddie Mac.

Now in normal times, Fannie and Freddie purchase mortgages issued by banks in order to clear up their balance sheet and allow the banks to serve as efficient sources of capital. But now banks that were issuing mortgages on second-homes have started reducing the amount of loans they were willing to make. That’s because Fannie and Freddie are capping the number of non-primary residence mortgages it purchases from banks, and banks don’t want to sit with those mortgages on their balance sheet.

Fannie Mae and Freddie Mac’s government backing is critical to keeping mortgage rates down but they’ve started to grow worried of systemic risks emerging from low-interest rates. And a reduction in new mortgages could lead to a self-fulfilling prophecy.

Because without new buyers, vacation home prices plummet.

For Now Prices Are Soaring

Home price growth rose to a 15-year high earlier this year, leaving many middle-income families and laid-off workers on the sidelines who are struggling to make ends meet.

Second home buyers and investors accounted for 14% of all purchase-mortgage applications in February. The new restrictions say that no more than 7% of the mortgages that lenders sell to Fannie or Freddie can be tied to second homes or investment properties. With that said, many purchases of second-homes don’t actually need a mortgage, or can procure cheaper forms of financing.

That’s where a bubble could emerge. The cap is centered on the overall dollar volume of loans purchased by Fannie and Freddie, though it’s specific to mortgages. And while a lot of this fear can be overblown and perhaps can be written off, the inverse effect Covid-19 has had on the housing market is strange.

Bottom Line

Strange should worry investors. While a slowing economy typically suppresses home prices, white collar workers have fared well, keeping their jobs and saving money by not commuting to the office.

Additionally, record-low mortgage rates and stir crazy city dwellers eager to escape cramped living have fueled bidding wars and sight-unseen purchases across America’s vacation zones.

But as investors expect that to continue, will secondary home prices rise to far? And perhaps inflation isn’t impacting eggs, but it is impacting home prices.