Down Payment, Financial Constraints among Factors That Shape Housing Demand, Study Says

Housing MarketTwo Federal Reserve Bank of New York researchers published a new paper that shows, using business analytics, how down payment and wealth constraints play a role in determining housing demand, particularly when it comes to less affluent consumers.

Study authors Andreas Fuster and Basit Zafar used a different set of economic principles when trying to gauge housing demand, going against the classical Keynesian-based theory of user cost that is typically used in other reports.

Extrapolating the theories of economist John Maynard Keynes into the housing market, the user cost paradigm or model makes use of down payment size, individual discount rates, after-tax mortgage rates, property taxes, maintenance costs, insurance costs, and future rent growth as statistical variables to determine the equilibrium between rents and prices. However, this classical model was not used by the New York Federal Reserve researchers, which makes their report extremely fascinating.

Instead of sticking to traditional theorems and conventions, Fuster and Zafar used the New York Fed’s Survey of Consumer Expectations as a gauge to determine how willing a home buyer is willing to pay for property given various down payment, interest rate, and non-housing wealth-related hypothetical scenarios.

According to the report, home buyers are not as sensitive to mortgage rate gyrations as they ostensibly are on the user-cost model. One of the more simple examples is how a 200 basis point (2 percentage point) increase in interest rates would result in a 5 percent decrease in a consumer’s willingness to pay.

What was even more interesting was how less affluent consumers, especially renters, are more willing to pay should they be offered a lower down payment. The willingness to pay of renters, according to the New York Fed’s survey, goes up by 40 percent if down payment requirements are reduced from 20 percent to only 5 percent. With government-sponsored enterprises Fannie Mae and Freddie Mac recently having instituted new reforms that reduce minimum down payments to 3 percent for select consumers, this should give younger consumers, especially renters, the impetus to purchase their first home.

Non-housing wealth was one of the more unusual variables used by the research team. In another simple example given by the New York Fed, a $100,000 increase to this statistical variable increases willingness to pay by an average of 10 percent. The effect, however, is four times more puissant when it comes to renters, who would then become 40 percent more willing to pay.

Regardless of the models used by economists and financial strategies, the New York Fed’s paper provided empirical evidence that mortgage standards, may they be determined by financial institutions or the federal government, are important when trying to measure housing demand, especially with regards to less affluent consumers. Income and mortgage interest rates remain, all things considered, important variables in gauging demand, but the lack of activity among first-time buyers (“fence sitting,” as described colloquially) is largely a result of stringent mortgager requirements and a lack of access to non-housing wealth. This also proves once again that while home price increases have benefited the broader U.S. economy, they have also resulted in many younger consumers being “shut out” of the market.