Pending Homes Sales Drop: Deflationary Spiral or Temporary Slowdown?

Buyers signed fewer contracts to buy homes in May than in any time since the government starting keeping records on them. Based on information from the National Association of Realtors, pending home sales dropped 30 percent from April -- from 110.9 to 77.6 -- which is also 15.9 percent below May 2009.

While some believe this may be a sign the housing market cannot survive without life support from the government, take a breath and think about where we are. Some do think we're heading into a deflationary spiral, with housing prices again taking another big fall. But many others have been expecting the drop.

It's not hard to think about a doomsday scenario with today's pending homes report and the report that new home construction fell 2 percent. In addition we continue to hear about flat sales in the new homes market. Last week's new homes report indicated that sales dropped 33 percent to a pace that is slowest seen since records started being kept 47 years ago.

But Celia Chen, of Moody's said that new homes data is "volatile" and Moody's is expecting that the numbers "could be revised upward" next month. She added that Moody's does not think we're headed into a deflationary spiral.
Chen says Moody's has been expecting a "slowdown after the mad rush" to buy homes before the tax credit expired. That happened on April 30, when buyers had to have a completed purchase contract in order to qualify for the tax credit. So summer sales were "brought forward." Yet she does expect to see a rebound off the low May numbers in June.

Another key factor in the slowdown in home purchases is the mortgage process itself, Chen said. It's taking much longer to get mortgage approvals so closings are being delayed.

Chen said the fundamentals for the housing market were basically pretty good. She pointed to low interest rates and affordable house prices as two key factors in favor of an improving market. She said Moody's also expects to see improvements in jobs, which will ultimately benefit home sales as more people can afford to buy a house.

National Association of Realtors' Chief Economist Lawrence Yun also expected the drop. "Consumers are rational and they rushed to meet the tax credit eligibility deadline in April. The sharp decline in contract signings in May is a natural result with similar low levels of sales activity anticipated in June," he said.

Yun expects existing-home sale closings will "remain elevated" in June, but then expects a drop off in closings for July and August. Now that Congress has reauthorized the National Flood Insurance Program, that will enable more closings. Many lenders would not close on homes that needed flood insurance, without Congressional action. The action is retroactive to a temporary authorization that expired May 31, and also is expected to be signed by the president.

Another major factor that will keep the housing market afloat through the summer is the expected extension of the tax credit deadline until Sept. 30, to give people more time to close on the contracts signed by the April 30 deadline. Prior to Congress' approval of the extension, the NAR predicted that about 180,000 people may not be able to close on contracts that were delayed by the mortgage process.

So before you start thinking deflationary spiral and a second bust in the housing market, think about the foundation that is in place for recovery. Expect some slowdown since people bought earlier than planned to get the tax credit, but look for improvements as house prices and interest rates continue to keep house purchases affordable.

The key and missing ingredient for a full recovery: jobs. If the job market improves, so will the housing market.

Lita Epstein has written more than 25 books, including "The 250 Questions Everyone Should Ask About Buying Foreclosures."

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