Whither Mortgage Rates?

The Mortgage Corner

Ok, the fats in the fire now with the Fed saying it will begin to taper its QE3 purchases that have been holding down mortgage rates by the end of 2013. Rates have been surging since then. The 30-year conforming fixed rate guaranteed by Fannie Mae and Freddie Mac is up almost 1 percent in 1 month.

So how much will this crimp the housing recovery, just now gathering steam? The all important single-family housing starts in May (that helps to determine whether the homeownership rate will increase) was at a rate of 599,000, according to the National Association of Home Builders and has been rising since January 2011, up some 33 percent from its most recent low.

This is why builder confidence in new-home construction has increased, as we said. But with 30-year conforming fixed rates now 4.25 percent, up from 3.50 percent as recently as the week before Bernanke’s first pronouncement that QE3 would be on the wane by year end, the rising costs will hit those in the lower income brackets.

For instance at the $208,000 national median home price the monthly payment would increase just $49/mo with a 20 percent down payment, a 6 percent increase. But the result is magnified in the debt to income ratio requirement for qualification, which is 43 percent. The qualification income would have to be approximately 5 percent higher, or housing price 5 percent lower, equal to $197,600, a $10,400 reduction in buying power, assuming other debts are equal.

So this would affect entry-level, first time homebuyers for the most part. But that is about 40 percent of home purchases during normal times. So in effect the Federal Reserve is cutting loose first-time homebuyers from the possibility of purchasing anything but so-called “affordable” housing with mandated price controls. And we know how few affordable units are built even during normal times.

Of course should Fannie Mae and Freddie Mac return to the private sector from government conservatorship, entry-level home buying could continue, since their interest rates have historically been lower than that of commercial banks. Critics have said this is because of the “implicit” government guaranteed to bail them out, and their thin market capitalization.

But their profits have been boosted by record-low interest rates, a booming housing market, and Fannie and Freddie’s very low default rates; the result of strict underwriting guidelines that require excellent credit, adequate income and assets.

There is in fact no reason banks can’t return to the mortgage market on their own, rather than rely on Fannie and Freddie, who now guarantee some 90 percent of mortgages originated. Renown banking analyst Richard Bove predicts banks are at the beginning of a record run in profits that could last 14 years.

“"What I'm suggesting is for the next 14 years — you'll have some setbacks, some recessions — (but) bank earnings will do what they did from 1992 to 2006," he said. "They're going to go straight up."

Even better news is that inventories of existing homes continue to increase from record lows as banks continue to decrease their holdings of distressed homes. So far in 2013, inventory is up 14.9 percent, according to Housing Tracker. But inventory is still very low, down 15.8 percent from the same week last year according to Housing Tracker. 

Graph: Calculated Risk

Calculated Risk’s Bill McBride opines that inventory is well above the peak percentage increases for 2011 and 2012, which suggests that inventory is near the bottom. I believe it can only go up from now, as I said last week. The reason is housing values continue to increase, up as much as 25 percent from their lows in Florida, California, and Nevada, states hardest hit by the housing bust.

The bottom line is activity in the housing sector is heating up with existing-home sales rising 4.2 percent to a seasonally adjusted annual rate of 5.18 million in May from 4.97 million in April, and is 12.9 percent above the 4.59 million-unit pace in May 2012.

Graph: Calculated Risk

Total housing inventory at the end of May rose 3.3 percent to 2.22 million existing homes available for sale, which represents a 5.1-month supply at the current sales pace, down from 5.2 months in April. Listed inventory is 10.1 percent below a year ago, when there was a 6.5-month supply.

The only fly in this ointment is whether mortgage rates will continue to rise. This might also slow price increases as borrowers find it harder to qualify for larger loan amounts.

But rates can’t go much higher for the moment, unless and until we approach fuller employment and economic growth really takes off. It would trigger the end of QE3 altogether and perhaps the Fed beginning to raise shorter term rates. But that is the best of all worlds and means a return to more normal times, at last. For rising rates means a greater demand for money, due to a faster growing economy, something we all want.

Harlan Green © 2013

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