Down payments or interest rates more important? A Federal Reserve Bank of New York analysis.

There are people who buy new homes, and there is demand, an economic term that aims to characterize a universe of people who might be regarded as your home buyers. They're related, but they're sometimes confused (more likely by investors, lenders, media types, and other outsiders-looking-in than builders themselves) as one and the same.

So, we'll look at this analysis from the Federal Reserve Bank of New York, which concludes that down payments are a more material inhibitor to demand than interest rate payments, with a big grain of salt. NY Fed research economists Andreas Fuster and Basit Zafar have been on a passionate pursuit--"at the intersection of policy and research"--to solve a critically important question about what's holding back the housing recovery from returning to norms at a more secure pace and trajectory.

One of the ways to phrase the question is this: "Are people who could buy a home--either with discretionary cash and income capacity or who would qualify in today's stricter regulatory credit environment--not pulling the trigger because of 1) down payments, or 2) interest rates?" Now, Fuster and Zafar's work, on one level, goes into empirical, statistical calculations that make our heads spin, like this basic rent-to-price ratio formula that sits at the basis of their study, "the simple no-arbitrage assumption that in equilibrium, the net present costs of renting and owning should be equalized." Here's what that looks like:

Rent-to-price ratio equalized... Federal Reserve Bank of New York
Rent-to-price (R/P) ratio.


Put some of that in your Friday morning coffee, eh? So, there are two great insights in this work. One is its focus on an acronym "WTP," which stands for Willingness to Pay, and is measured via the empirical data, for sensitivity to both interest rate gyrations and down payment changes.

From this concept of Willingness to Pay, we look back at the notion of demand. Now, true demand consists of a universe of people who, in fact and according to banks and regulators, qualify as able to repay, or "ATR." Where ATR meets WTP is the juncture that Fuster and Zafar shine their lens on. Willingness to Pay is a subset of those who are Able to Repay, some of whom opt out of homeownership all together, and some of whom decide--based on the variables Fuster and Zafar are looking at--whether they're going to go ahead and enter the fray of trying to line up financing to buy a home.

For them, the solutions to the inquiry point quite possibly toward support of policy measures around down payment assistance, a grey-area tactic that may well stimulate demand, but which stirs debate over whether it heaps greater risk into mortgage lending calculations.

The other very interesting part of Fuster and Zafar's work is this. They go beyond rework and repurposing of found data, understanding that some of what they're after involves choices people make given moving-target economic circumstances. In their own words:

To circumvent this “identification problem” (in econonerd speak), we do something rather unusual in economic research: we just ask people.

Novel idea in research, to actually go out and talk to people who are behaving the way they do, not in a historical pattern sense, but according to conditions and variables that exist today.

Now, we know that your focus is best on the real-life, real-world customer prospects, the ones who search your sites, who gather data on your models, the communities' distance from meaningful parts of their lives, like jobs, schools, other family members, friends, churches, fun, etc. Ones, too, who venture into your sales centers, tour your model parks, check out the lots that are coming online and the home plans that go with them. If you were to concern yourself with pie-in-the-sky models of demand, you, too, would be working with Fuster and Zafar at the NY Fed.

That said, sitting in our "ivory tower" here in Washington, DC, we can not help but think about demand in that macroeconomic sense, which mustn't matter a whole lot right now, but that do impact us deeply.

When someone's strolling through a model home, or scrolling through a virtual tour, the first thing that comes to your mind is not, "this is pent-up demand." The first thing that comes to your mind is, "what can I do to bring this person or couple or family across the line?"

We know that your land acquisition plays model themselves around a business plan that solves for those real-world, real life folks who are showing up either physically or digitally in their course of research on what the best option to meet real, driving, emotion-riddled motivations and needs.

That "down payment trumps interest rates" may be an important conclusion at "the intersection of policy and research," but it's also pretty important for you to know that when you're trying to manage a potential buyer off the sidelines and into your fold.

It suggests that among those who'd qualify as "able to repay," there are some who are "willing to pay" and some, for reasons relating to the down payment hurdle, decide that they're not "willing to pay."

Some builders will regard that obstacle as an opportunity. Will you?