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A New Source of Shadow Inventory

Rising Rates May be Driving a Substantial Increase in the Shadow Inventory

Mark Fleming    |    Mortgage Performance

Last week, I wrote about the rise of housing obsolescence and shadow demand as one of the possible reasons for weak housing demand. Home sales aren’t increasing because even though there are buyers ready to own a home, they can’t find anything they want to purchase. In addition to that increasing “shadow demand,” there could be another reason for the low number of homes for sale and weak purchase activity: a new component of the shadow inventory.

Earlier this month, CoreLogic estimated that 1.7 million homes were in the shadow inventory as of January 2014, which is almost half of the 3 million homes that were in the shadows when the inventory peaked in January 2010. We have traditionally defined shadow inventory as the number of homes with mortgages that are 90 or more days delinquent and that we believe will move into foreclosure to ultimately become real-estate owned (REO) properties in the for-sale inventory, though they are not yet listed on multiple listing services.

But that traditional view of shadow inventory doesn’t tell the whole story anymore. Because of what’s happening in the market now, the definition should be expanded to include non-distressed existing homeowners who have no incentive to sell because the prevailing mortgage rate is higher than their current mortgage rate. In the chart, the active-loan-count share is shown by mortgage rate bucket. More than a third of all active mortgages currently have a mortgage rate below 4 percent, and another 15 percent are just below or slightly above the current market rate of 4.3 percent. Essentially, roughly half of all active mortgaged homes have below-market-rate mortgages. There are approximately 50 million mortgaged homes in the United States, and conventional wisdom is that homeowners typically sell once every seven years. Therefore, very simply, there are an estimated 3.57 million likely sellers who may be discouraged from listing their homes for sale because the cost of financing the next home they buy will be higher.

Adding these rate-disenfranchised sellers to the traditional shadow inventory results in a new estimate of 5.27 million homes as of January 2014. For the sake of comparison, a year ago, when the current interest rate was less than 4 percent, the share-below-market rate was smaller at approximately 28 percent. At that point, only 2 million likely sellers were discouraged from selling, and the expanded shadow inventory would have been 4.2 million homes, as opposed to the estimated 2.2 million homes included under the traditional definition.

If you’re looking for more inventory and home sales, look no further than to the existing homeowners hanging back in the shadows. The shadow inventory now likely includes a large number of homeowners who would sell their homes and subsequently buy a new one, but they are less likely to participate because they have a below-market mortgage rate. This group of potential, inactive buyers could keep growing as mortgage rates continue to edge upward, putting yet another damper on the recovering housing market. We thought the shadow inventory was improving, but rising rates may actually be driving a substantial increase instead.

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