Why the Housing Market Can't Move On Without More First-Time Homebuyers

A dearth of first-time homebuyers could hobble the housing recovery, currently fueled by investors.

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Home values are now increasing nationwide. While that's certainly better than the alternative, a deeper dive into the data reveals a serious crack in the foundation: too few first-time homebuyers.

First-time homebuyers are the vital first rung on the home ownership ladder. They are usually buying from a seller who is "trading up" to a more expensive home or building a new one. When potential new buyers sit on the sidelines, existing homeowners are stuck, unable to move out and up.

In October, the first-time buyer's share of the purchase market stood at about 35 percent according to the Campbell/Inside Mortgage Finance HousingPulse Survey. That's down from 37 percent as recently as June and it's the lowest percentage recorded in the survey's history. Typically, a healthy housing market sees first-time homebuyers occupy around 40 percent of the purchase market.

[READ: 5 Predictions for the Housing Market in 2013]

The survey results also revealed that first-time homebuyers heavily relied on the Federal Housing Administration for financing, thanks to its low down-payment requirement of 3.5 percent. With the FHA's recent announcement that it will tighten credit standards, first-time homebuyers will see the barrier to homeownership grow even more.

House sold
House sold

But it's not just a tightening credit market that's squeezing first-time homebuyers. Enticed by historically low but increasing home prices, rising rents, and record-low interest rates, yield-hungry investors ranging from giant hedge funds to cash-rich seniors are crowding out crucial first-time buyers. In red-hot Phoenix, for example, investors have purchased more than 30 percent of all single-family houses and condominiums sold in 2012, and those numbers are rising.

But a closer look at the widely followed Standard & Poor's/Case-Shiller Home Price indices reveals two trends that might blunt enthusiasm about recent returns for investors. First, on a month-to-month basis, home price gains are slowing in key metro regions. Atlanta, dubbed the "Phoenix of the East," suddenly saw prices peak in June, and then drop dramatically.

Second, year-over-year increases in home values will begin to wane as many metro regions approach the one-year anniversary of their lowest price points. This is significant since many areas have seen considerable yearly gains and those numbers have been a large part of the media narrative, in turn enticing more investors to enter the market.

[RELATED: Home-Builder Confidence at 6-Year High]

To boost first-time sales, lawmakers should focus on promoting a culture of savings among future homeowners. Homeowners who come to the table with larger down payments have more options in homes and choices in financing, which will result in lower monthly mortgage payments and higher levels of home equity. Stable housing markets, with reasonable levels of appreciation, will nurture economic growth and encourage private lending.

One way to foster a culture of savings is a "Home K Account," which would create a sub-account in current retirement savings plans, such as 401(k) plans. This would allow first-time homebuyers to save for a down payment on a tax-preferred basis. Workers are facing increasing threats to retirement security in the shadow of looming entitlement reforms, and too many Americans are forced to choose between saving for retirement and saving for a down payment. Or worse, they've given up on both. By encouraging saving for both kinds of assets, Home K Accounts would help America make the transition from a debt society to an equity society.

This is not a one-size fits all solution, but a piece of the puzzle. We need more jobs and increasing wages. We need fresh ideas to help low-income home buyers that don't simply saddle them with costly, highly leveraged loans.

Whatever the policy prescription, we should encourage savings. It's the only way we will begin to build a pipeline of responsible, sustainable homeowners.

Jason R. Gold is director of the Progressive Policy Institute's "Rethinking U.S. Housing Policy Project" and senior fellow for financial services policy. Keep up with his work at PPI here.

Corrected on : Updated 1/3/13: This article has been updated to explicitly identify the data source for the first-time buyer’s share of the purchase market.