Credit Bonanza! Is it?

Emerging Market Series, Eastern Europe, Romania
So it finally happened. The BNR (Central Bank of Romania) decided to drop the minimum requirement barrier and allow the banks to decide based on their credit system evaluation what the population’s level of debt should be. Additionally, the banks will determine what will be the minimum down payment for their new and existing customers. The BNR would like to see a qualifying ratio of 35%. That means the monthly principle and interest payment cannot exceed 35% of the median family monthly income.
Already, we see that Primary Banks are “breaching” this level with 30% for BRD and low or no initial down payment. So what does this all mean to the average family of Romania? Based on several “Specialized” real estate agencies – don’t hold your breath – the housing market is only heating up. Only in Bucharest alone according to several brokers there are over 750,000 new habitants coming into the market. Is this so? Last time we checked the population of Romania was diminishing with many participants leaving the labor and looking overseas for better “paid” work. This is not to mention that many if not all these who are working abroad have any access to local bank for credits since they can’t provide income qualification. Or maybe the banks will just issue credit to just about everyone? Have they not learned from their counterparts overseas?
It is hard to believe that the credit markets around the globe are tightening up after the collapse in the Sub-prime landing. So where are all these people coming from? Probably many are swapping the apartments and they probably are not even affected by the new rate system. Or is just because all agencies post similar ads, we have an “artificial” price? Probably a combination of both.
So now we are asking. Will the credit bonanza announced catapult the real estate prices through the stratosphere? Hard to believe considering that there is no correlation between the average income levels and the real estate prices. Only yesterday the INS reported the April monthly average income level of 308 Euros, a 1.7% increase over March level. This includes the Easter bonus etc. So what does this mean for a family of 2 working people with an average of 620 Euros? Assuming no down payment, for a 6% APR (Annual Percentage Rate) to be extremely conservative, a 30 year fix mortgage loan will qualify the family in the best case scenario for a 103,410 Euro mortgage. A 70% debt ratio to income will allow the same family a mortgage of only 72,387 Euros. No PMI* (Private Mortgage Insurance) is included on the first 20% down payment that the bank will ask for, nor do we speculate on the standard of living that an average family will have when all their incomes will be locked in the mortgage payments.
It is possible that many “qualified buyers” will go into debt for speculative reasons only resulting in temporary price appreciation. If this is the case how will they afford the payments? Maybe they will rent out units. It means rents have to go up to 600 Euros/month to justify those prices… hard to believe.
It is likely the CPI (Consumer Price Index), which the BNR is trying to keep under 5% will skyrocket. After all there is plenty of “free money” which will have an exponential effect on the multiplier, especially if this money will be used for discretionary spending.
So who are the winners and who are the losers? Banks evidently are going to take huge risks by allowing consumers to take large debts. Insurances will charge premium on naked mortgages that either banks will pass to buyers thereby resulting in larger mortgage payments, or simply will absorb. The most recent American Housing Bubble followed by the Sub prime Lending should raise a red flag. Winners are major material and construction companies who will take the lion’s share with an already overheated housing sector ready to accelerate. This may raise subsequently the price of commodities and natural resources. Ultimately the labor cost will have to rise to keep up with demand.
Did the BNR open a Pandora Box by eliminating any restrictions on credit? This is a question that will be answered soon. One way or another market will find equilibrium. In a perfect scenario, the overheated house prices will come down to match the existing affordability level, This is sustainable if supply of housing keeps up with demand and if banks recognize and prevent the potential of a crisis that lays within their hands. Or maybe the Romanian government should introduce an index of affordability such as US-NAR (National Association of Realtors)*.
The affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home. A typical home is defined as the national median-priced, existing single-family home as calculated by NAR. The typical family is defined as one earning the median family income. The prevailing mortgage interest rate is the effective rate on loans closed on existing homes from the Federal Housing Finance Board These components are used to determine if the median income family can qualify for a mortgage on a typical home.
Interpreting the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20% down payment. For example, a composite HAI of 120.0 means a family earning the median family income has 120% of the income necessary to qualify for a conventional loan covering 80% of a median-priced existing single-family home. An increase in the HAI, then, shows that this family is more able to afford the median priced home. The calculation assumes a down payment of 20% of the home price and it assumes a qualifying ratio of 25%.That means the monthly principle and interest payment cannot exceed 25% of the median family monthly income. In addition to providing a composite index, the monthly report breaks the index down by fixed-rate mortgages and adjustable-rate mortgages. It’s also broken down by region.
How is it used? The index helps analysts understand consumer’s ability to purchase a home. The monthly index tends to receive the most attention because of its timeliness. It’s also valued because it breaks the index down by mortgage type and geographical region.
Why use it?
First, falling mortgage rates can actually improve affordability when the overall economy is growing below its potential. Mortgage rates are closely tied to the yield of the 10-year Treasury note, which is tied to expectations of inflation and economic growth. If inflation or economic growth expectations or both are subdued, the yield of the 10-year Treasury note usually falls, thereby bringing mortgage rates down to more affordable levels. Yet, inflation typically has a greater affect on the movement of the yield of the 10-year Treasury note and mortgage rates.
Example, if the economy is expanding at a solid pace, supported by robust productivity growth, inflation would likely be contained. This could keep the yield of the 10-year Treasury note subdued and mortgage rates relatively affordable.
Second, home prices are also affected by the health of the economy. If the economy is strong, it likely means home prices are rising. But is this necessarily a bad situation? It probably isn’t for consumers in general because family incomes could also be rising, thereby improving home affordability from that perspective. Furthermore, it clearly isn’t negative for established homeowners because they build greater equity and that provides a source for consumer spending.
However, rising home prices clearly hurt affordability for first-time buyers. Consequently, analysts use the affordability index for first-time buyers in conjunction with various other reports to gauge how the impact from rising home prices is affecting overall economy growth. In conclusion, the credit bonanza, might only heat up the already inflated real estate bubble.
Horatiu Tocan
* Lenders mortgage insurance (LMI), also known as private mortgage insurance (PMI), is insurance payable to a lender that may be required when taking out a mortgage loan. It is an insurance in the case that the mortgagor is not able to repay the loan, and the lender is not able to recover its costs after foreclosing the loan and selling the mortgaged property. The annual cost of PMI varies between 0.19% and 0.9% of the total loan value, depending on the loan term, loan type and proportion of the total home value that is financed.