Wednesday, June 9, 2010

Why Real Estate Prices Should Fall

There is nothing more important to the price of your home, the office you work at, or the building where you do your shopping than leverage. Leverage can be defined as credit, debt, or the ability and cost at which to finance real estate.

While many books and articles have been written to show how an increase in leverage and credit caused the price of real estate in our country to skyrocket to bubble levels, very few seem to understand that the coming lack of leverage will in return bring real estate prices far lower.

If more buyers are able to secure mortgages due to relaxed qualification standards such as credit scores, down payments, and income requirements then the demand for housing will increase as there is a larger pool of potential home buyers.

The exact opposite is true when credit contracts. As lending restrictions tighten, the pool of potential home buyers becomes smaller and demand will in turn be far lower.

In a normal real estate cycle home prices will then correct downward until they reach a level where buyers can once again afford a home with realistic qualifications.

However, this downturn in the real estate cycle has been different from those seen in the past. Our government has stepped in and now provides or guarantees close to 100% of new mortgage loans currently being made.

This has temporarily stemmed the price fall for homes that fall under the FHA maximum loan limit. In the Charlotte area this loan limit is currently at $303,750. Under an FHA loan a buyer needs no cash reserves (savings), 3.5% down payment, and lower credit scores than a conventional loans.

What this means is that the American tax payer has become the credit market for residential real estate. They have become the leverage, and they stand ready to pay for any losses incurred as a result of lending with these relaxed qualification standards.

So they question is, how long can the government continue to provide leverage to keep the real estate market artificially afloat?

That question needs to be determined by looking at the strength of the Federal government itself. Is it good debt, or bad debt?

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