Is homeownership on the way out?

Sure seems that way, at least according to recent reports. A new Urban Institute study points to an increase in household formation among lower-earning minorities who may not have the means to afford much more than a monthly rent check. A survey by Wells Fargo last summer suggested that high debt levels are holding back millennials from becoming homeowners as well.

If true, this doesn’t bode well for residential real estate developers. It’s certainly not good news for existing homeowners with properties to sell, either. What’s more, a shrinking inventory of affordable rental units could drive up rents, and housing sales may also come under pressure as lenders tighten underwriting standards for fear that values may once again decline.

All this is happening despite government policies that are biased in favor of homeownership (consumer-friendly regulations and tax policies in particular). That and, until recently, an upward spiral in valuations have conditioned consumers to view ownership as an ideal worthy of great personal sacrifice.

Achieving that ideal, however, can also expose them to risks that may not be worth taking.

Consider as an example the adjustable-rate mortgage: A cut-rate loan product that’s touted by banks, mortgage brokers and real estate agents as a way for aspirant homeowners who are rolling the dice on higher future salaries and increasing home values to afford their dreams with the help of tantalizingly low monthly payments at the start of the loan.

The story behind the scenes, though, is a bit different.

The term adjustable is marketing-speak for “variable” or “floating,” in that the interest rate can move any which way. The rate is typically tied to LIBOR or a similar index, and resets at specified intervals — from monthly up to several years at a time — depending on the terms of the ARM. This can be beneficial for the borrower if the interest rates drop in the interim, resulting in a lower payment; or can have disastrous results if they increase to the point of unaffordability. So borrowers who require lower monthly payments early on to make their deals work must also accept longer-term uncertainty in exchange; risks that fixed-rate mortgage lenders had traditionally assumed.

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Mitchell D. Weiss