Is It Finally Time to Buy a House?

According to the most recent data, foreclosure activity in the U.S. is at its lowest level since July 2006. All foreclosure-related metrics dropped in September, including the number of homes repossessed, the number of properties set for foreclosure auctions, and the number of default notices issued.

Source: flickr user Nick Bastian.

While this is definitely a good sign, it doesn't necessarily mean that home prices are going to continue on their upward trajectory. Rather, it does mean that the housing market is returning to a "healthy" state. But what does that mean to you?

The data looks great
Foreclosure activity in the U.S. is now at an eight-year low. According to RealtyTrac, there were 106,866 foreclosure filings across the country, which is 8.6% less than in August, and represents a year-over-year drop of 18.6%.

In fact, overall foreclosure activity, which includes foreclosure notices, auctions, and repossessions, is now back down to pre-bubble levels, according to the report. The number of lender-repossessed homes in September dropped by 13% from the month before, default notices given to homeowners dropped by nearly 10%, and the number of homes set for foreclosure auctions dropped by 5.5%.

Why home prices may actually cool off now
Despite this good news, home prices aren't necessarily going to continue on their upward trajectory. Since bottoming in early 2012, U.S. home prices have gained nearly 25% in value, and have actually pulled back a little bit recently.

Case-Shiller Home Price Index: Composite 20 Chart

The foreclosure market was one of the big reasons for these gains. Generally, foreclosed homes sell for lower prices than traditionally sold homes. In fact, RealtyTrac also reports that the median sales price for a foreclosed home was 36% less than that of non-distressed sales. As foreclosures have been gradually working their way out of the market, home prices have naturally risen faster than they normally would, simply because there are fewer foreclosures holding the average price down.

There are other factors that could drive home prices a little lower in the short term. A big one is the seasonality of the housing market. Generally, summer is the peak selling time for homes, as kids are out of school, and it's simply more convenient to move. With summer ending, selling activity is probably going to cool off considerably.

Thanks to higher prices, activity may cool off even more this year than in most years. The recent mortgage application data shows purchase applications are actually 4% lower than they were at this time last year. The inventory of existing homes on the market has actually risen by about 24% in 2014 as sellers try to take advantage of higher prices, while the rate of sales has increased by just about 4%. The laws of supply and demand tell us that high inventory plus lower demand means prices are likely to drop a little bit.

US Existing Home Inventory Chart

What a healthy market looks like, and what it means to homebuyers
In a healthy market, real estate gradually appreciates by a low single-digit percentage. Gains like we saw before the market collapsed and the declines that resulted from the bubble bursting are not healthy.

Take a look at the chart below, which tracks U.S. home prices since 1991. The market of the 1990s was pretty healthy. The market of the past decade or so has not been healthy.

US House Price Index Chart

We may see a small drop in price as the market becomes healthy again as prices adjust to normal supply and demand dynamics again. However, without a massive amount of foreclosure activity, there should be much less volatility in the housing market going forward. In other words, if you have been putting off buying a home, you can now buy with a little more confidence.

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