Concerns over the stability of the U.S. banking system is spilling over into the housing sector as experts worry about credit drying up for home builders.

The collapse of banks such as Silicon Valley Bank and Signature Bank has spooked many investors who have withdrawn vast sums of money from regional banks and moved it to bigger financial institutions for safekeeping.

With an uncertain economic outlook, experts worry about the availability of credit for home builders and mortgage lenders, which could hurt the housing market.

Wall Street is anticipating tighter credit conditions for the U.S. economy in the months ahead. Goldman Sachs recently lowered its forecast for U.S. economic growth, expecting small and medium-sized banks to scale back lending, to preserve liquidity.

That pullback is likely to hit home builders, which could hurt housing supply, Robert Dietz, chief economist at the National Association of Homebuilders said.

Builders are worried “about their ability to obtain debt financing to acquire and develop lots,” Dietz told MarketWatch. “Most of that financing originates with the regional bank system, which is under some pressure given recent events.”

With the U.S. already experiencing a housing deficit, the squeeze in credit availability could continue to keep the cost of homeownership high as supply remains tight. The U.S. is short of 2.3 million homes, according to calculations by Realtor.com®.

(Realtor.com is operated by News Corp subsidiary Move Inc., and MarketWatch is a unit of Dow Jones, also a subsidiary of News Corp.)

Many builders have used rate buydowns, price cuts, and other incentives in their financial arsenal to bring down the cost of new construction to boost sales. That may come to an end, Lisa Sturtevant, chief economist at Bright MLS, told MarketWatch.

“More difficulties borrowing will mean some builders will have less flexibility to offer buydowns and other financial incentives,” she explained.

Housing starts rose nearly 10% in February, with construction on apartments surging in the Midwest. It’s the first time in six months that housing starts have risen.

But that strength “is in question,” Ali Wolf, chief economist at Zonda, told MarketWatch, “as it’s unlikely that we’re out of the woods related to the financial sector.”

Like Dietz, Wolf said she expects builders who work with smaller and regional banks will find it harder to access credit now than in the years prior.

“There may be interest to build more homes, but total volume may be held back by reduced financing,” she added.

The availability of mortgages for home buyers is a different story.

Over the last decade, small domestic commercial banks have ramped up their mortgage business, as seen from the chart below from Apollo’s Torsten Slok.

Now the uncertain economic outlook doesn’t necessarily mean bad news.

Concern about job security amid a recession slows demand, which pushes sales down. And smaller banks may be more reluctant to lend, given their need to boost their reserves.

Data from the Mortgage Bankers Association revealed that mortgage credit availability dropped in February by 3% to the lowest level since January 2013, indicating that lending standards are tightening.

Yet a slower economy helps lower mortgage rates. Concern about a recession – which indicates the possibility of the U.S. Federal Reserve backing off of aggressive rate hikes – pushes investors into the 10-year Treasury, which then pressures mortgage rates downwards.

Freddie Mac said that the 30-year mortgage rate dropped in the latest week to 6.6%.

As rates drop, buyers are returning to the market, private data reveals. According to Redfin, a record number of would-be buyers locked in a rate as of Friday with its mortgage lending company than any other day so far in 2023.

And mortgage demand overall jumped in the last week, according to the Mortgage Bankers Association.

“There isn’t any evidence — yet — that the banking instability will lead to homebuyers having difficulties taking out a mortgage,” Sturtevant said

“In the near term, the current situation is leading to falling mortgage rates, which is bringing more opportunities to prospective buyers and homeowners looking to refinance,” she added.

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