What buyers don’t know when boom times become recessions can’t hurt them, right? Wrong, but it is an empirical moment experienced primarily by boom-time buyers with a mortgage. A little knowledge might avoid the hurt.
Poor financial literacy
For California’s recent homebuyers, the financial literacy penalty far exceeds the average national dollar amount. This exaction is especially acute for buyers who bought their homes within four years before and two years after home prices peaked in May 2022. For the gatekeepers licensed by the DRE, this does not come as a surprise.
For a buyer acquiring real estate ownership during the years of 2018 to 2024 who funded the price they paid using borrowed capital — a mortgage — they have committed the financial malfeasance of leveraged buying at the top of the market. The years 2020 and 2021 were particularly off the rails in the midst of a pandemic-distorted economy driven by fears of disease and missing out. A great percentage of people surged in the same direction at the same time, and with little thought; the results were as expected.
Financial education is the information gap
Financial acumen — the ability of an individual in a real estate transaction to understand and apply financial skills — is typically accumulated over a period comprising at least one business cycle during which direct involvement in real estate transactions takes place, either as a buyer or as an agent rendering services to buyers, sellers and owners. Academic schooling helps a lot.
Yet, California is one of just five states in the U.S. with no financial literacy education requirements for K-12 public schools. Further, only 20% of teachers feel confident enough to teach on the subject, according to the Council of Economic Education.
High school financial literacy requirements in California have long been advocated by firsttuesday. Without an education in household economics, individuals are unprepared to make financially responsible decisions in a real estate transaction. They lack the ability to make prudent decisions.
Especially true when a homebuyer originates a mortgage, the most consequential financial decision most homebuyers make in their lifetime. A mortgage, due to its pervasive magnitude, leans into every other decision they make for a generation.
For example, during the refinancing boom in the 2020-2022 pandemic period of historically low mortgage rates, low-income homeowners were underrepresented in the pool of mortgage refinance applications, according to a Federal Deposit Insurance Corporation (FDIC) working paper on refinancing inequality during the COVID-19 pandemic.
Savings produced in the pandemic by an interest expense reduction through refinancing were concentrated among higher-income earners. Low-income homeowners generally missed out on refinancing to reduce their mortgage payments at historically low interest rates — an opportunity to increase their disposable income and standard of living. This financial result of improved financials was exactly what the Federal Reserve intended when they set mortgage rates extremely low.
The disparity between savings for high- and low-income borrowers was tenfold during the first half of 2020 in comparison to the pre-pandemic response — a chasm not attributable to variables like credit scores, loan-to-value ratios (LTV), principal balances and ageing.
For mortgage loan originators (MLOs), this gap directly translates to a reduced income from opportunities missed due to a financial crisis. The same conclusion holds true for the early months of a sustained recovery following the 2023-2024 recession, likely around 2027.
Homeowners of color also missed on savings
Weak knowledge about personal finance coupled with low income only exacerbates a larger looming statewide dilemma for real estate financing: racial inequity.
Even before the pandemic, homeowners of color enjoyed less favorable mortgage terms than white homeowners. Between 2005 and 2020, Black homeowners paid up to 50 basis points more on mortgage interest rates than white homeowners, according to a Federal Reserve Bank of Atlanta report.
White homeowners are more likely to refinance or move during periods of low mortgage rates. This decision suggests white homeowners have likely acquired an awareness of financial arrangements. The report concedes Black and Latino homeowners benefit from periods of lower mortgage rates, but they benefit much less than white homeowners. So why the disparity?
Observable differences such as credit scores and LTVs across homeowners explain about 80% of the difference, but the remaining gap is explained as resulting from:
- different levels of education and financial acumen;
- greater exposure to loss of employment that restricts the ability to obtain non-predatory financing to purchase consumer products, such as a home; and
- social networks.
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Nationally, 60% of white Americans were able to answer half of a financial literacy test correctly, in comparison to less than 33% of Black Americans, according to TIAA.
Further, many would-be homebuyers of color are mentally conditioned to rent, often based on their family’s deep-rooted lack of intergenerational financial knowledge.
Only 37% of homebuyers of color are saving to buy a home — while most people of color aren’t saving at all, are expecting to always rent, and may never own a home, according to Rocket Homes.
Editor’s note: firsttuesday’s two-hour Implicit Bias training prepares real estate professionals to identify and counteract elements of systemic racism — conscious and unconscious — in real estate transactions. Visit firsttuesday.us to enroll.
Current firsttuesday students may access their required course by logging into their existing accounts. Students who are not yet enrolled may visit the order page.
Related Video: Civil Rights and Fair Housing Laws
Click here for more information on fair housing history.
2023 financial real(i)ty check
In California, nearly 59% of residents are still recovering from the financial setback of the pandemic in the wake of its economically devastating disruption, according to Hometap. Today, you may properly relate to the toll taking place in 2023 as the Fed fights to correct the current surge in consumer inflation flowing from the pandemic-driven stimulus bridge, etc.
While mortgage delinquencies in California reached a historical low between 2021 and 2022, they have reversed and are now climbing, up from November 2021:
- 0.7% in Los Angeles-Long Beach-Anaheim; and
- 0.4% in San Francisco-Oakland-Hayward, according to Core Logic.
Out of the existing 14.3 million housing units in California, 3,426 of the SFRs have gone into foreclosure, the 12th highest foreclosure rate nationally. Additionally, in February 2023, there were 2,133 foreclosure starts in comparison to the 1,869 foreclosure starts a year prior, according to ATTOM.
To cushion the recessionary headwinds of lost income, homeowners need to consider:
- reducing budgeted spending to preserve cash;
- selling belongings to gather cash;
- downsizing their housing or renting out a room to cut expenses;
- enrolling in a forbearance or mortgage modification program to preserve monthly income; and
- seeking temporary assistance from family, friends and agencies, according to Hometap.
Further, many homeowners have little to no knowledge of the specifics of their finances, such as how much money they owe, until they’re already too deep in debt. In a peculiar national lack of awareness about personal affairs in a functioning capitalistic economy, only 46% of homeowners know how much debt they owe.
While all variety of markets continue to shrink in 2023-2025, forward-looking agents and brokers need to counsel the homeowners and buyers they work with about the alternative financial paths available to them regarding mortgaged ownership, such as a financial reality check personal to each of them.
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Getting your head into debt
To better manage debt, families need to conduct a financial analysis of their net worth and debt ratios at least once each calendar year. Mortgage lenders do this for applicants, but that relationship is adversarial, not advisory as is a real estate agent’s.
To easily achieve this objective, families fill out a balance sheet, also known as a statement of financial position, to create a display — spreadsheet — of their current assets and debt. [See RPI Form 209-3]
By identifying and entering the dollar amount of all their assets and liabilities on the balance sheet, a family develops a better understanding of their accumulated wealth and total amount of debt they owe. A balance sheet review becomes an analysis for financial decisions they might make when acquiring assets. This is not budgeting, which is a cash-flow study of your profit and loss (P&L) income statement.
Information requested and entered in an application for a mortgage sought to fund the purchase of a home or refinance an existing mortgage is also a balance sheet. But the lender has no obligation to advise a borrower on what is in the borrower’s best interest. That task is the job of the borrower’s real estate agent.
To keep yourself and your property owners and buyers updated about financial conditions in this recession, read Quilix, firsttuesday’s weekly newsletter contribution to the industry.
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