Higher Mortgage Rates Won’t Kill Housing Recovery

August 6, 2013 By In Uncategorized No Comment

Mortgage rates are back above 4% for the first time in a year, but the rate rise probably isn’t going to be enough to take the wind out of the sails of the housing market rebound.

The Mortgage Bankers Association reported on Wednesday that rates jumped to 4.07% last week for the 30-year fixed-rate loan, up from 3.9% in the previous week. At the beginning of May, rates stood at 3.59%, according to the same MBA survey.

Mortgage rates tend to track yields on 10-year Treasury notes, which have jumped as anxious investors sell off Treasury securities amid signs that the Federal Reserve may begin to slow down the bond-buying program it launched last year. Bond yields rise as prices fall. By midday Wednesday, yields on the 10-year Treasury were 2.09%, down from a high of 2.24% last week but up from a low of 1.62 at the beginning of May.

What does it all mean for the housing market? Already, refinancing activity has fallen like a rock. Mortgage lenders had more business than they could handle last year thanks to major refinance demand. Mortgage originations hit a five-year high as rates dropped to their lowest levels on record and as the government revamped a major initiative to refinance loans backed by Fannie Mae and Freddie Mac even if borrowers owe more than their homes are worth.

Refinancing might still make sense for some borrowers who haven’t taken advantage of government initiatives and who have high mortgage rates, but as long as rates stay above 4%, refinancing activity will be muted for everyone else. Loan applications to refinance dropped 15% last week from the previous week and is at its lowest level since November 2011, according to the MBA.

Home buyers, however, will be less sensitive to rates than those seeking a refinance. A rule of thumb holds that every one percentage point increase in mortgage rates makes homes about 10% more expensive for buyers by increasing the monthly mortgage payment. The bottom line: if higher rates are here to stay, that could take some of the edge off of recent price increases.

There are two big reasons to suggest modest increases in rates won’t cause major damage for the housing market. First, all-cash purchases have accounted for a significant share of home sales in recent months. Second, housing is still extremely affordable — and mortgage rates, even at 4.07%, are lower than they have been at almost any time from the early 1950s until August 2011.

“Housing can remain affordable by historical standards even if interest rates rise,” wrote Goldman Sachs economists Hui Shan and Marty Young in a research note this week. They say interest rates, given the recent half-percentage point rise, don’t change their expectation for home prices to rise by 4% to 5% annually over the next few years.

Goldman runs an exercise that shows just how affordable housing is, even if rates rise. They assume the typical homebuyer has an annual household income of $50,000, pays a 20% down payment, and obtains a 30-year fixed-rate mortgage. At an interest rate of 3.8%, the average homebuyer can afford a house worth $279,000, which is 45% above the current median sales price of previously owned homes. Even if interest rates rise to 6%, homes would still be affordable to this median borrower because prices are still so low.

Rising rates “will likely slow the strong house price appreciation observed over the past year, but the impact will likely be modest given the cushion provided by the high level of housing affordability at present,” the Goldman economists write.

A similar analysis from  Trulia Inc., the online real-estate site, shows that homeownership still beats renting even if interest rates are higher. In March, the cost of owning a home was 44% cheaper than renting assuming a 3.5% mortgage rate. Buying would be 39% cheaper than renting with rates at 4.5%, and owning would be 33% cheaper at a 5.5% rate.

One question some buyers (and many would-be refinancers) are asking: will rates make it back down to 3.5%? It’s impossible to predict the future, but if economic indicators this summer disappoint — Friday’s jobs report will be the next major gauge of the economy’s fitness — then bond yields could drop, leading to lower mortgage rates. If indicators suggest the economy is indeed on better footing, then rates could stay where they are or move higher in anticipation of a Fed pullback later this year.

Some analysts have also speculated that rising rates could boost housing demand in the immediate future. That seems less likely. True, rising rates could encourage people who were already looking for homes to pull the trigger now, rather than in a few months. But mortgage bankers say it’s unusual for truly undecided home shoppers to choose to purchase because of rising rates. “Rising rates induce anxiety,” says Lou Barnes, a mortgage banker in Boulder, Colo.

Still, there are few signs that the current uptick in rates has led to any pullback in demand. Barnes said that in the Denver metro area, buyers are unfazed. The rate increase is “just bouncing off everybody,” he said. Mortgage applications for purchases dipped by 2% last week from the prior week, but were 14% above last year’s levels, according to the Mortgage Bankers Association

Source: Nick Timiraos

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