How Will the Mortgage Market Handle Higher Interest Rates?
Long-term U.S. mortgage interest rates have likely hit bottom and are likely on their way back up. Improvements in the housing market are helping push rates higher, but will the market be able to sustain its current strides if interest rates rise substantially?
The average commitment rate on a 30-year conventional, fixed rate mortgage rose about a half a point in May, according to mortgage finance giant Freddie Mac, hitting a one-year high and making the largest leap in years. Still, rates are around all-time lows, an indication of the depth of the Great Recession. By historical standards, rates could rise another two points and remain extremely affordable.
Yet the Federal Reserve has hinted that it might reduce its efforts to keep rates low sooner than previously thought. That has sent Treasury bond yields soaring, and mortgage rates tend to follow those yields. As the Fed slows its purchase of mortgage-backed securities in the coming months, long-term rates may stretch above four percent again by the end of the year.
Some analysts believe this may actually be a good thing for the mortgage market, at least temporarily. It will motivate more fence-sitters to enter the home buying process.
"When we see an uptick in interest rates, people start to get that feeling that they might have missed the bottom of the market - which they have already," said Steve Goddard, an agent with Re/Max Estate Properties in Manhattan Beach, Calif. in an LA Times article. "But sometimes fear is an important factor in buying property," he said. "The interest rates are still very, very good, and people who want to buy a property, if they can, should be out there trying to buy."
Rising rates may bring a new wave of buyers to the mortgage table, hopefully replacing a lot of the business that will be lost on refinance loans. During the last week of May, increasing rates had weakened borrower interest in refinancing by 12 percent, the largest weekly drop in all of 2013. Yet more Americans were applying for home purchase loans, increasing 3 percent from the previous week. Refinances still made up 71 percent of all applications though, meaning many more homebuyers will have to step up to fill the gap that will be left by lower refinance demand.
Even if higher interest rates entice more buyers into the market, it is hard to tell how long that will affect home sales. If rates continue to travel upward, "you might spike the market for six months as people rush to buy," said Christopher Thornberg of Beacon Economics in a USA Today article. After that, the hope is that demand will return to equilibrium with housing supply.
Few experts believe that rates will rise dramatically in the next year though. "We're seeing the first steps in a gradual uptick," said Freddie Mac vice president and chief economist Frank Nothaft. He cited the Fed's last meeting notes where the group promised not to make major monetary policy changes until unemployment drops to 6.5 percent. And with the rate currently around 7.5 percent, mortgage rates will probably see only a gentle upward trajectory.
If they do rise faster than expected, however, it still might be a positive for the housing market.
"You have to look at the big picture," says Guy Cecala, head of Inside Mortgage Finance, an industry publication. "Historically low rates are generally a sign of a weak economy. When things improve rates should rise noticeably."