The FED Just RESET The Housing Market

What's up, Graham? It's guys here, and you're not going to believe this. In the middle of a real estate slowdown, a possible 30% hit to home prices, and seven percent mortgage rates, a brand new policy was just released that would loosen credit score requirements and make it easier for a buyer to get approved for a loan. That's right! After 20 years relying on FICO scores, starting soon they're going to be a prehistoric thing in the past.

Even though this would allow many more people to qualify for a home, some analysts worry that this comes at a time where deals are being canceled, inventory is building, and a new buyer might not be fully aware of what's about to come. So, let's talk about these new confirmed changes that are about to go into effect, how this is going to impact the overall housing market, and whether or not home prices could see their second worst crash since World War II.

On this episode of "Millennials are still spending too much money," although, before we start, as usual, if you appreciate information like this, it would sincerely mean a lot to me if you hit the like button or subscribed if you haven't done that already. It's totally free; takes you just a split second, and as a thank you, I will do my best to respond to as many comments as I can.

All right, now in terms of where this starts, as most of you know, your credit score is the single most influential deciding factor for all things personal finance, building wealth, and buying real estate. But now, that's sufficiently coming to an end. That's because a new report just revealed that 53% of Americans are getting turned down due to bad credit, leading both Congress and big banks to take matters into their own hands to develop an entirely new credit scoring algorithm that would replace the current system as we know it. This would allow people to get a loan without having a traditional credit score and take brand new items into consideration that could either help or hurt you, depending on the situation.

Now, in terms of how this applies to the housing market, here's where things get really interesting. Even though the typical mortgage borrower has a credit score of 725, 35% of Americans have a score below 680. So, by expanding credit worthiness across a larger pool of buyers, housing accessibility is about to get a lot easier and cheaper for those you know to look out for.

Even more important is that this isn't just speculation or a proposal from a senator you've never heard from; this is actually going into effect. So, it's crucial to understand exactly what's going on, how this is about to impact you, and the steps that you could take ahead of time to put yourself in the best position possible to use this to your advantage.

All of this begins with what's known as an alternative credit score. See, as it is right now, borrowers have five main categories if they want the highest chances of getting approved at the lowest rate. The first and largest factor is based on your on-time payment history, which makes up 35% of your score. This means you always pay your bills on time as agreed, without ever missing a payment or being late, and the longer the history you have making those payments on time, the better your score is going to be.

The second largest impact is what's known as your utilization rate; that makes up 30% of your score. This calculates how much credit you have available versus how much of it you use, and the lower the ratio is, the higher the chances of getting approved. Third, we have the average age of your credit, which makes up 15% of your score overall. Lenders see that the longer you've had your accounts open for and in good standing, the higher the chances that you'll be a responsible, experienced borrower.

Then fourth, we have the types of credit that you have, and that makes up another 10% of your score. For instance, it helps to have the experience of paying off multiple credit cards, auto loans, personal loans, and mortgages in various amounts to show lenders that you have experience handling multiple types of debt. Finally, we have the remaining 10% of your score, which is calculated based on the number of credit inquiries that you have.

See, anytime you apply for a new line of credit, it shows as a hard inquiry in your report, and generally speaking, the more inquiries you have, the lower your score is going to be because you tend to be a riskier borrower the more you seek out active lines of credit.

Now, even though this has been the tried and true method of building credit for the last 20 years, lenders realize that this might exclude great, well-paying, responsible people who should be getting a loan but can't because they don't have the knowledge, means, or the need to go and borrow money to build their credit score. So they came up with a brand new solution that's about to come to the markets known as FICO 10T and the Vantage score.

Now, first, it's important to mention that FICO scoring methods are constantly updated every few years to account for new data trends and spending habits. For instance, they made changes with FICO 8 that would ignore small unpaid balances of less than a hundred dollars. They then began accounting for buy now pay later balances that were previously invisible, and FICO 10 had the ability to see if your spending habits were increasing over time.

But like I mentioned earlier, there were some major flaws in the system, most notably that 45 million Americans didn't even have a credit score. Forty percent have no idea how their score is determined, and 53% of them get turned down due to bad credit. That means that a significant portion of the population does not have access to affordable financing, the ability to buy a house, or the chance to leverage their money, and that is something that big banks and Congress are beginning to change.

Under this new program, banks would be allowed to think about other aspects of a person's finances into consideration, like their average account balance over time and whether or not they've ever overdrafted. In terms of the impact, Vantage score estimated that this would allow credit access to 72,000 more households every single year, opening the door for so many more people to get access to financing.

Second, the government housing agencies Fannie Mae and Freddie Mac have approved FICO 10T and Vantage scores to be used for home financing. As MarketWatch explains, both FICO 10T and Vantage scores will look at a broader range of payment history data for borrowers, from cell phone bills to utility and rental payments, to determine credit worthiness. Basically, in other words, their studies have found that if you pay your rent, utilities, and phone payment on time, then most likely, you're also going to pay your mortgage on time, even if you don't have a traditional credit score.

Although in terms of how this is going to impact you, along with the effect it's going to have on the real estate market, here's what you need to know.

All right, now before we talk about the effects that the new credit scoring model will have on the housing market, we first have to talk about housing prices because there is a lot of new information that is worth discussing. First, a recent report found that home prices are still more expensive today than they were a year ago, but gains are shrinking at the fastest pace on record since they started reporting in 1987. As they say, this data clearly shows that the growth rate of housing peaked in the spring of 2022 and has been declining ever since.

Now, in terms of which city saw the largest price drops, the award right now goes to San Francisco, down 4.3%, Seattle down 3.9%, and San Diego down 2.8%. But I have to say, when it comes to real estate, no one seems to be quite as pessimistic as finance professor Jeremy Siegel. With mortgage applications at the lowest level since 1997, he believes that housing prices will decline 10 to 15% over the next 12 months and that it could be the second biggest housing decline since post-World War II.

Mark Zandi, the second, is saying that most declines will happen sooner rather than later and that housing prices will fall 20% if there's a typical recession. Now, in terms of the data, though, Redfin found that in September, 60,000 real estate deals were canceled, and less than half of all offers faced any competition, unlike a year ago when the majority of homes went into a bidding war. As far as how long this might last, they believe that the housing market is not going to recover until the Federal Reserve begins lowering their interest rates, which they predict will happen around mid-2023.

However, what's really unique about this market is that housing prices are beginning to fall despite record low inventory in the market. See, historically low inventory would translate to higher housing prices because buyers would have less to choose from, but in this case, even though we're above the February 2022 lows, we're still significantly under pre-pandemic levels. This suggests that sellers don't want to give up a low-interest fixed-rate mortgage, and buyers can't afford to pay seven percent.

But for anyone who's looking to buy today, if the current rates remain, the median U.S. household would spend nearly 42% of its gross monthly income in mortgage payments—a huge figure that shattered the previous record of 40% in 2006, just before the housing market collapsed.

Now, in terms of how this new credit scoring model will affect the housing market, it's important to discuss both the good and the bad. And to start off on a positive note, one, FICO scores are not an accurate representation of how likely someone is to pay back a loan. The fact is, a credit score is only one small component of a person's financial stability. Other factors should include an average bank account balance, whether they spend more money than they make, whether or not they've ever overdrafted or bounced a check, if they pay the rent on time, and if they get all the way up to a hundred dollars when they stand up for FTX, us down below in the description with the code GRAHAM.

Second, this allows far more people access to affordable credit that could save them money. As it is right now, if you have a lower than average credit score, you'll have no other choice other than to pay a higher interest rate or get flat out denied. As a result, those people are held even further behind and wind up paying more money for the exact same service, even if they've never paid late in their entire life. A new scoring model would help bridge that gap and give more people affordable options that have the ability to repay.

And third, by taking more data into consideration, in theory, your credit score should be a lot more accurate. Of course, you would hope that this would boost your score and work in your favor if you've been an upstanding credit citizen, but the reality is you'll qualify more appropriately for whatever it is that you want.

But on the downside, one, critics argue that the new score would make millions of Americans appear safer than they actually are, diluting the value of the credit report and score. Like right now, the effectiveness of credit scores is entirely dependent on erring on the side of caution. If too many people suddenly get a boosted credit score without a proven track record, that could undermine the calculation while companies are on the hook paying for defaults.

Two, according to TransUnion, consumers with thin credit files are more likely to default on their loans, even though many of them do perform well. On top of that, FICO estimates that almost a third of people with no credit score have had a major negative impact on their credit history, like a bankruptcy, which means they tend to be riskier borrowers, but not always.

And three, there's always the possibility that banks and lenders simply want to issue more loans out there, and they're looking for an easier way to do that. This would open up more than 45 million more Americans who could borrow money and take out a loan, and that could be big business depending on the situation.

Obviously, this business is entirely dependent on those customers actually paying them back, but opening up new credit options could be coming from a good place, although it's too early to tell. I mean, if we see 45 million people rushing into the housing market all at once, it could be a disaster. But most likely, the people who are barely on the edge of getting approved will have an easier time getting a loan, and to a small degree, it could lead to a slight increase in sales.

But realistically, it's probably not going to have that big of an effect on the market since they're already going to have to come up with the down payment, have sufficient employment history, and have the income to get approved for the loan in the first place. So credit will get you through the door, but it's not enough on its own to get you approved.

Now, in terms of my own thoughts when it comes to credit, I am a fan of anything that promotes more accuracy, and I think it's a move in the right direction. After all, the traditional system of getting a credit card, putting charges on it, and then paying it off in full for the sake of building credit is pretty ridiculous, and there's no reason why phone, utility, and rental payments shouldn't be used in conjunction with everything else.

However, there's certainly the suspicion that banks are pushing for less restrictions so that they can issue and sell more loans. But in the big picture, I don't expect this to have a major influence on the market, and if anything, it's going to take lenders some time to adjust to, so we're unlikely to see anything happening in the short term.

Although as far as housing prices are concerned, I tend to agree with the analysts that housing prices have to come down because current levels cannot be sustained when mortgage rates just rose as much and as fast as they did. Even for investment properties, it makes no sense to buy a building with a four percent return when treasuries are paying a risk-free four and a half percent.

In normal markets, properties like that have to pay a risk premium of two to three percent for all the work that goes into managing it, so at today's rates, that property would have to sell for seven percent to even make it worth buying. That leads me to believe that the market will continue to cool down depending on the area, and as long as the Federal Reserve is increasing rates, we're likely to see some downward pressure.

Plus, real estate is cyclical, and with the market having already increased so much over these last two years, it makes sense that we're about to see a decline. Plus, at least on the bright side, one analyst says the Fed's flushing of inflation and dumping the punch bowl should lead to a new bull market for stocks, bonds, and other risk assets with a fresh start beginning in 2024.

So, don't despair; that's less than 15 months away.

So with that, city guys, thank you so much for watching. As always, feel free to add me on Instagram, and until next time!