Home prices continue to rise across the country. According to the July S&P Corelogic Case-Shiller index there was a 4.8% year-over-year increase in home prices. This was up from the 4.3% increase the previous month. The price increases in the 10- and 20-city indexes came in at lower rates of 3.3% and 3.9%, respectively. This indicates that price increases outside of the major cities are moving ahead at higher rates. Shrinking inventory of homes for sale likely contributed to the increases as noted in the NY Times. Another contributing factor is the lowest mortgage rates on record.

As in always the case individual cities saw increases at different rates. Seattle (7.0%), Charlotte (6.0%) and Tampa (5.9%) saw the highest year-over-year increases. Other cities pulled the overall index back including New York (1.3%), Chicago (0.8%) and San Francisco (2.5%) all below average. New York was the one city with price declines in the past 2 months albeit a modest -0.1% each month. Demand for units in Manhattan is down with sales down 46% in the third quarter while inventory increased 27% as reported in the NY Times. While the median price increased covid-19 is impacting demand to some degree.

Low interest rates have had a big impact on both refinancing and new home purchases. The low rates should increase the average life of these loans since there will be little incentive to refinance in the future. Despite the longer life the net effect on CECL reserves likely will be minimal provided home values continue to increase at an even modest rate.

The much more significant impact relates to those future home values. Demand for homes are driven by new household formations which are in a long-term decline due to demographics and limits on immigration. Affordability also impacts demand. As interest rates increase (almost certain to happen in the next 2-5 years) affordability will decline, reducing demand or prices. As prices have gone up lenders face a risk that collateral values will decline which increases the risk of future losses.

In the near term as foreclosure moratoriums expire defaults and foreclosures will accelerate dramatically in some markets unless jobs make a dramatic comeback. Even then, some families' finances will be damaged beyond repair so even if they get their jobs back they may never be able to bring themselves fully current. The increase in home prices should minimize write-offs but not the costs of processing foreclosures. Refinancing some of these loans at lower rates may be an option as permitted by policy exceptions.

But the long-term impacts of higher rates and potential price declines create concerns about future losses. These should be factored into loss estimates taking into account current loan-to-value policies and the mix of new loans by a range of risk factors such as FICO scores and equity amounts. It is not likely that we will see anything approaching default rates and losses from the Great Recession. But the reliance on inflated home values does increase future risks that should be monitored to incorporate into future loss estimates.