has an interesting article on rising mortgage rates and the impact on the housing market. While the increases still seem relatively low in comparison to what they were a few years ago, the rise is steady and is indicative of the trend in the mortgage industry.
Read the full article:
Mortgage interest rates are rising. In the week ending June 6, the 30-year fixed-rate mortgage clocked 3.91% in its fifth consecutive weekly gain, according to Freddie Mac, after hitting its highest level in a year last week. That’s 18% higher than the 3.31% record low set in November of 2012 and almost 17% higher than the 3.35% rate logged at the beginning of May. The 15-year fixed-rate broke above 3% as well, to 3.03%.
Compared to a month ago, the increase translates into an extra $30 per month for every $100,000 of debt accrued. If rates continue their upward march, mortgages will become more expensive.
Since cheap financing has been a notable driver of the housing recovery, could those rising rates derail the momentum? To answer that question, let’s first take a look at what low-interest rates have done for housing and why they’re increasing now.
Compared to decades past, today’s rates (even at 3.91%) are unprecedentedly — and artificially — low. They’re the direct result of a Federal Reserve-funded fiscal stimulus plan, better known as the third round of quantitative easing or QE3, aimed at hastening the recovery in housing and the economy as a whole. Through the program the Fed has been buying $85 billion worth of Treasury bonds and mortgage-backed securities per month, a process that has tamped down interest rates, making mortgages more attractive to prospective consumers.
The low rates have enabled qualified home buyers (and owners looking to refinance) to access cheap financing, adding to already-record-high levels of home affordability. It’s helped bolster a surge in both home sales and price increases (since lower rates help make larger principals possible).
Rates are climbing now due to both stronger economic data and to speculation: recently Fed chairman Ben Bernanke suggested that the central bank may start slowing its bond-buying within the next several months. The news has caused bond investors to begin selling out of their 10-year Treasury positions, driving yields for these bonds above 2%. Since mortgage rates correlate closely with Treasury yields, they have followed suit, rising about a quarter of a percentage point in just a week.
Many economists believe those numbers will continue to climb, albeit at a more modest, uneven pace throughout the year. “I anticipate that the rate [for a 30-year fixed mortgage] will probably go up to 5% by the end of next year. So from now until next year, the general direction will be upward,” says Lawrence Yun, chief economist for the National Association of Realtors. Doug Lebda, chief executive of mortgage shopping site LendingTree believes rates will be volatile on their upward ascent, logging both periods of increases and renewed decreases throughout 2013.
Whatever the growth pattern, as rates rise, some markets will be affected more than others. “In Middle America, I don’t see much impact since homes are so affordable,” explains Yun. “The more expensive coastal regions… is where one will begin to feel the first decline or impact.” He suspects that California metro areas and east coast hubs like Boston, New York, and Washington D.C. could begin to experience slackening sales because low-interest monthly mortgage payments in these relatively pricier places have helped make homes seem more affordable to more buyers despite the fact that relative to income, principal amounts are still expensive.
In April Zillow Z +5.93% found that housing affordability hinges heavily on low mortgage rates — dynamic masking fundamentally high home price-to-income level ratios. Relative to local median income, which has remained largely stagnant, homes are trading at prices higher than historic (and healthy) norms in 24 of the largest 30 metro areas, according to the Seattle-based real estate site. If rates rise before income levels can keep pace, sales activity could taper and in some areas, prices could again dip down as the market corrects.
“Current affordability is almost entirely dependent on low-interest rates, and there’s no doubt that rates will begin to rise in the next few years,” asserted Stan Humphries, chief economist of Zillow. ”This will have an undeniable effect on demand for housing, as home buyers will have to spend more of their incomes to buy a home. Home values will have to either remain stagnant while incomes catch up or, quite possibly, home values will have to fall in some markets. This will especially be the case in some markets that have seen strong home value appreciation.” Like Yun, Zillow points to Calif. metros like San Jose and Los Angeles as some of the areas most artificially buoyed by low-interest rates.
Still, some economists think a slight increase in interest rates wouldn’t necessarily be a bad thing — even if sales activity did slow somewhat in the process. ”I think [raising rates] may cool off some of the frothiness in housing, but unless we get a big spike in rates, I think we’re still in the early-to-mid innings of a pretty long recovery in housing,” says John Canally, investment strategist at LPL Financial. That “frothiness” has led to bidding wars in the most sought-after markets, fueling dramatic double-digit price gains on a rapidly dwindling inventory supply.
The first thing rising rates affect is refinanced applications. Refi apps have fallen for the past several weeks, logging a 15% drop (after accounting for Memorial Day) last week from the week before, according to the Mortgage Bankers Association. Mortgage applications have begun to tick down too, falling 11.5% from the week earlier. Yet if rates continue to rise, it might spur qualified home buyers sitting on the fence to make purchases before financing becomes any more expensive, facilitating a short-term uptick in home sales.
Rising rates could create a long-term benefit for the market as well: slightly looser lending standards. Real estate experts have lamented how exceedingly tight credit has been — even for buyers who on paper qualify for mortgages. As my colleague Steve Schaefer reported last week, David Blitzer, chairman of the S&P Dow Jones Indices index committee, voiced concern over the difficulty consumers have faced trying to secure financing. Lenders have been overly cautious about underwriting new mortgages in large part because the returns associated with low rates haven’t necessarily matched the level of risk.
“Now that prices are rising, there is far less default risk for people taking out mortgages so if the credit standard is dialed back down toward normal from stringent, I think we could easily negate the impact of rising rates,” says Yun.
Canally believes rates have a little room to rise before it’s the time to step back and assess their impact on the larger market as a whole, pointing to 4.5% for a 30-year fixed loan as the first benchmark for analysis. He also notes that if rates rise to this level, presumably, it’s because the economy is improving. Indeed the Federal Reserve has said it would not begin scaling back its bond-buying program until the unemployment rate reaches 6.5%. It’s currently at 7.5%.
Also worth noting: residential real estate investment contributed to the gross domestic product in 2012 for the first time in five years. While robust sales activity plays a role, the majority of housing-related economic growth stems from residential construction, or new home building and remodeling.
While interest rates certainly warrant attention, many economists say there more pressing issues that threaten to impede upon the housing recovery. Among them: tight inventory levels and an uncertain regulatory environment.
Tight inventory has led to nascent housing shortages in some areas of the country and impeded the number of existing-home sales, according to NAR. At the current sales pace, the U.S. has a five-month supply of existing homes for sale; a healthy market supply is six months. The dearth of inventory coupled with a burgeoning buyer base has caused home prices to nationally jump by double-digits, gains that are not sustainable in a healthy market.