House prices will continue to drop. The reason is simply supply and demand. There are lots of houses for sale and too few buyers. Why are their too few buyers? Lets list the reasons
1) The speculative buyers are gone. Speculative buyers are non-existent when prices are dropping. They know there is no point in buying until prices level off. They were probably at least 10% of the market at the top of the bubble.
2) The subprime and other uncreditworthy buyers can no longer get loans even if they wanted them. They were at least 20% of the market at the top of the bubble.
3) Before the bust, you didn't need a down-payment. Now you do. A 20% downpayment on an average $200K house is $40K. In addition, many banks now want to see enough liquid resources, cash, bonds etc, to cover 6 months of principal and interest. That adds another $6K for this house. How many people have $46K sitting around in cash? We don't need to speculate. A Met Life study was just published on this. The question was, "How long could you meet your financial obligations if you lost your job. Only 15% of people said longer than 6 months. For people younger than age 44, the natural home buyer demographic, the percentage is 9.5%. But to put down a 20% down payment you would really need this answer to be at least a year. The number who answered that was 10% overall and 5% for those under age 44. How horrifying is that statistic for those hoping the housing market will rebound? The stringent requirements on down payment and liquid resources now being demanded by banks can be met by about 5% of the natural home buying population!
4) If people had money before the bust, they probably lost much of it in the stock market. If you were young and were saving up money to eventually buy a house, you probably had most of that in the stock market. That is what your financial advisor would have told you to do. If you are young, you want a "risky" portfolio they said. You probably have about 40% less now.
If indeed you just lost 40% of your wealth, you are probably not looking to make major purchase, especially an asset that is still falling dramatically in value. In addition, you are probably worried about losing your job in this terrible economy. So why buy until the economy recovers and you are sure your job is safe.
So to sum up, about 70% of households do not have enough liquid savings to buy a house. This may be even higher for the subset of people that no not already own a house. The supply of possible home buyers is probably only 1/5 of what it was at the top. The supply of homes is only down about 20% from the peak. So supply and demand imbalances mean that house prices will continue to fall until a balance is reached. There is only two ways out of this situation. One is to wait several years for people to save money and for house prices to fall to more affordable levels. The other is for the government to subsidize housing and bring the uncreditworthy back into the market. I don't see that happening given all the anger at these junk mortgages being made in the first place.
Now there is mortgage insurance and FHA for people with no down payments but that adds more in fees on top of higher mortgage rates for people with poor credit. These people are probably paying 8% interest rates including MI. Why not wait? If you wait, you can save money to increase your down-payment, improve your credit score and in addition benefit from the fall in house prices. In addition, there is talk that the Obama administration will offer 4.5% fixed rate mortgages to help move housing inventory. If you wait a couple of years, save money, get a much lower interest rate and benefit from a 20% drop in home prices, you might reduce your mortgage payment by almost half.
So waiting is the obvious thing to do. Because of this, house prices should drop for another few years.
