The Next Decade for Mortgage Finance

Special Commentary from the Office of the Chief Economist
by Frank E. Nothaft, Freddie Mac's chief economist
June 23, 2004

America's families took out $15 trillion in single-family mortgage loans over the 1994-2003 decade. According to a new report issued by the Homeownership Alliance, America's mortgage credit needs will be twice as great over the coming decade. The report, America's Home Forecast: The Next Decade for Housing and Mortgage Finance, provides projections of both housing demand and the amount of credit that will be needed from the housing finance system.

Over the next decade, mortgage originations are projected to average nearly $3 trillion per year. Residential mortgage debt is projected to grow at close to an 8.25-percent annualized rate, which would more than double the amount of debt outstanding, to more than $17 trillion.

Drivers of Mortgage Credit

The mortgage credit needs of America's families are primarily determined by the growth in the number of households, the anticipated rise in the homeownership rate, appreciation in home values and greater leveraging of the housing stock. The effect of each of the four principal drivers of mortgage credit demand and their effect on single-family mortgage debt outstanding over the past decade and projected over 2004-2013 is summarized in Exhibit 1.

The market demand for mortgage credit is the sum of each individual's mortgage credit need. Growth in the number of households causes growth in overall market demand. The number of households grows over time because of natural increase (the excess of births over deaths), net immigration and factors that affect headship rates (the proportion of the population that chooses to form a household). Over the past decade, the number of households grew by 1.3 percent per year, and demographics point to growth at close to that rate through 2013.

Exhibit 1: Drivers of Single-family Mortgage Debt Growth
	Actual	Projected, 2004-2013
	1993-2003	Most Likely	Range
Household growth	1.3%	1.25%	1.1-1.4%
Ownership growth	0.6%	0.50%	0.3-0.6%
Price appreciation	5.3%	5.00%	4.0-6.0%
Leverage growth	1.5%	1.50%	1.4-1.6%
Single-family mortgage debt growth	8.6%	8.25%	7.0-9.5%

Note: For 1993-2003, the sum of the first four rows is 8.7%; the difference between this and the single-family mortgage debt growth rate of 8.6% reflects other factors that affect debt growth over time. The projected range of single-family mortgage debt growth was rounded to the nearest one-half percent.

Source of 1993-2003 data: U.S. Census Bureau, Freddie Mac, Federal Reserve Board

Increases in the homeownership rate also lead to larger volumes of mortgage demand. Homeowners are more likely to have a higher loan-to-value (LTV) ratio on their residence than on an investment property and are more likely to refinance the loan on their home. In particular, first-time homebuyers generally have limited liquid assets and make relatively small down payments. To illustrate the greater credit needs of homeowners, owner-occupied properties comprised 83 percent of the one- to four-family housing stock in 2001, but they accounted for 94 percent of the dollar volume of one- to four-family loan originations that year. Lower mortgage costs, new loan products and better consumer financial education will contribute to higher owner rates in the coming decade, especially for minorities. The U.S. homeownership rate should exceed 70 percent within the next few years.

Home-value appreciation has been the largest single component of the growth in mortgage credit demand. Economy-wide inflation increases the nominal amount of mortgage credit required by borrowers. In addition, since home values have grown faster than general price inflation over the past 50 years, mortgage credit demand has also grown in real (that is, inflation-adjusted) terms. Over the last decade, the annualized growth rate in home values has been about 5 percent. Appreciation is expected to average around 5 percent per year, close to the 50-year trend, over the next decade.

The aggregate leverage of the housing stock represents the total amount of mortgage debt outstanding divided by the value of the housing stock; in effect, leverage refers to the aggregate "LTV" ratio for the nation's housing stock. Increases in the utilization of mortgages by borrowers will increase the aggregate leveraging of the housing stock and contribute to mortgage credit demand. Improvements in technology, including broadened use of the Internet, and innovations in mortgage lending, including a wider range of mortgage products, have expanded the pool of potential mortgage borrowers. For example, combining Internet-based automated underwriting systems such as Freddie Mac's Loan Prospector^® with other online efficiencies can reduce borrowers' costs of origination by $800 to $2,100, speed up loan closings, and allow loan approval for borrowers with less-than-traditional credit profiles and limited savings. The increasing financial sophistication of America's families (who recognize mortgage finance as an inexpensive means to finance consumption and investment) and increases in homeownership will contribute to further growth in aggregate leverage.

Residential Mortgage Activity More than Doubles by 2013

As of year-end 2003, residential mortgage debt outstanding in the United States totaled $7.8 trillion, consisting of $7.3 trillion secured by one- to four-family homes and $0.5 trillion backed by multifamily properties of five or more dwelling units. This amount was more than double the amount of residential mortgage debt outstanding 10 years ago, or $3.4 trillion as of year-end 1993. Growth of 8.25 percent per year will lead to a similar increase in debt outstanding, a better than doubling of mortgage debt in the next decade, as shown in Exhibit 2. By the end of 2013, mortgage debt will total $17.2 trillion with an 8.25 percent annual increase; a faster growth rate of 9.5 percent per year will place the residential mortgage debt need for America at $19.2 trillion.

Exhibit 2: Residential Mortgage Debt More Than Doubles by 2013