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How Higher Mortgage Rates Effect Real Estate Affordability

The National Association of Realtors (NAR) has reported that the pace of sales for existing homes sales fell by 1.2% in June. The 5.08 million result was well below the market expectation for 5.27 million, prompting concern that higher mortgage rates are beginning to negatively impact the housing market.

Mortgage rates have jumped by about 1% since the mid-June Federal Open Market Committee meeting prompted investors to sell off Treasury bonds and causing rates to spike.

Investors reacted to Federal Reserve Chairman Ben Bernanke’s press conference, seemingly nervous that the Fed would reduce (a.k.a taper) their $85 billion per month stimulus program called “quantitative easing” (QE).

It was QE that helped rates drop in the first place, and as investors left the market, bond yields rose and rates followed. (Read more about the events here).

About one month has passed since that initial spike, and Wall Street Journal writer Nick Timiraos recommends waiting another month before judging sales data.

Jed Kolko pointed out that the drop in sales comes in part as foreclosure and short sale activity has declined.

Even as month-over-month data is down, over the previous year existing sales are up 15.2%. Meanwhile, prices continue to make significant, double digit gains.

Though the year-over-year data remains positive as we wait for additional monthly data, a few simple calculations suggest that higher rates pose a real danger to the housing market recovery.

Central Coast Lending owner Jason Grote walks us through the process.

“Matt” wants to buy a house. Matt will pay 10% down, and has a debt-to-income ratio (DTI) of 44%, which is the upper qualifying range for home loans. Debt-to-income shows what a borrower can afford given his/her income.

  • With a 3.375% mortgage rate, Matt can qualify for a $400,000 house.
  • With a 4.375% mortgage rate, Matt can qualify for a $365,000 house.
  • With a 5.375% mortgage rate, Matt can qualify for a $335,000 house.

The first scenario represents where we came from in May, the second where we are now, and the third where we could be going if unfettered gains continue.

Higher rates reduce what borrowers can afford, simple as that. With affordability in danger, demand will drop and home price gains will slow. The recovery will lose a great deal of momentum.

“Rapid interest rates jumps could take the wind out of the sales of the housing recovery,” said Grote.

Grote points out that if rates continue to rise, the Fed may need to jump back into action.

“I am a little disappointed, because the Fed spent trillions on keeping mortgage rates down and when Bernanke made what what felt like misinterpreted, if not errant comments, rates spiked by a point,” said Grote. “All they have done is try to talk their way out of it. If rates don’t ease up, I think the Fed may actually increase quantitative easing to prevent hurting the fragile housing market recovery.”

This week, rates continue to inch back down. Since the July 5 spike, we have seen about three weeks of price drops, though they are still roughly 1% higher than in May.

Track mortgage rate movement on the CCL Rate Tracker every Monday, Wednesday, and Friday. For the most recent rate update (July 22), see HERE.

Written by Central Coast Lending - Go to Central Coast Lending's Website/Profile
805.543.LOAN info@centralcoastlending.com