By Douglas Katz – 07/11/2022
CNBC recently reported that deal cancellations have risen to 15%. This is applicable to new and existing homes and, while not a harbinger of doom, it does reflect a sea change for the market. Killing deals was unheard of just a few months ago when homebuyers were willing to accept onerous contractual terms. As the market has stabilized or, as some pundits describe it, decelerated to a point where buyers are walking away.
The main reason cited in the article was the cancellation due to need. As I wrote in several articles, buyers should check in to see if their borrowing power had been impacted by rate increases. The speed at which mortgage rates have moved upward has been much more rapid than typical rate bumps. Many buyers did not keep up with the impact of the higher rates and are getting denied when they lock and go to underwriting. As the article references, lenders have some hard numbers for the debt ratios, both front and back-end. While some compensating factors can help, they are not a magical thing that nullify guidelines. Buyers need to revisit their numbers to avoid this, especially if they are tight. Sellers already ask for documented pre-approvals, but now I would expect to see them be even more discerning in their selection of who gets the deal. The weaker buyers will likely bee shut out if there are other buyers with better offers and stronger finances.
From the article:
Higher mortgage rates have also caused some borrowers to no longer qualify for the loans they want. Lenders generally use a front-end debt-to-income ratio of about 28% as the ceiling for home loans. The costs of owning a median-priced home in the second quarter required 31.5% of the average U.S. wage, according to a report by Attom, a property data provider. That’s the highest percentage since 2007 and up from 24% the year before, marking the biggest jump in more than two decades.
The truly heartbreaking scenarios are the new construction deals. In many of these, buyers put down sometimes sizable deposits on new homes with the expectation of a dream come true. The problem is the timeline left them vulnerable to market shifts and while long term rate locks were available they were expensive and many consumers felt that they were unnecessary with the long run of low rates. The change in the rate environment unfortunately hit hard and fast. Now many are losing the possibility of buying and possibly losing their deposits as well. I dealt with a good number of clients who were considering the new construction option and I ran a loan stress test for them to see the point at which their deal would be non-viable.
Another reason for buyers to reverse course is choice and not necessity. Being approved is not always the best this, especially when you consider that the debt ratios are based on GROSS income. It is not out of the realm of possibility that a buyer or buyers will re-evaluate the terms of a deal based on the payment exceeding their comfort zone as opposed to necessity. I have heard more references to house rich and cash poor in the last few weeks than the last two years. When they add inflation to their analysis, the high cost of a home becomes even more profound. This trend should also be a cautionary trigger for buyers who have not done the right amount if analysis on their personal budget and how the house will impact it.
The final reason that the article does not reference is buyer psychology. Sometimes buyers can afford the property, but the seller’s headspace is still mid-2021 when selling was like shooting fish in a barrel. Under these circumstances escalation clauses, appraisal waivers, “as-is” purchases and other onerous terms were common place. Inspections were to see how much more money a buyer may need for repairs and such as opposed to being a tool to restructure the deal if necessary to account for shortcomings in the home. In the past, the inability to reach an agreement would kill a deal, but the recent past was an anomaly. Now we are returning to sanity and clients are walking and sometimes they are doing so with a bad taste from an unreasonable seller. I can recall at least one buyer who made some demands after the inspection, was told to pound sand by the seller and walked. Soon after the seller returned with more than they asked for in concessions and the buyer refused, even without any offers out on other properties. Again, this would have been all but unheard of in the recent past, but things have changed and are continuing.
As with any data point, this is not a reason to head for the lifeboats. It is, however, another important indicator that the market is moving in a more balanced direction. Buyers should realize that they have a bit more leverage, especially if they are strong borrowers. Sellers need to be cautious and accept their degrading dominance in a deal. There is a cost to cancelled deals and in a volatile market with competition for good buyers, a seller could end up worse off than if they conceded a bit and under the worst cases out of luck.