May 29, 2009 / 8:49 PM / 10 years ago

U.S. mortgage rate rise threatens housing recovery

NEW YORK (Reuters) - A dizzying rise in U.S. mortgage rates this week has left homeowners worried about the government’s ability to revive the housing market as a means to economic recovery.

A house for sale has a "Reduced Price" sign in front of it in Dearborn, Michigan, March 27, 2009. REUTERS/Rebecca Cook

Higher mortgage rates could hinder a nascent rebound in housing this year, where cheaper loans and lower prices have enticed buyers to cut into the inventories of unsold homes.

Loan refinancings to take advantage of lower rates have also been key supports of the housing market in 2009, providing a rare bright spot for a market buffeted by rising defaults, foreclosures, and falling prices.

The level of interest rates is central to President Barack Obama’s efforts to break the decline in housing, where prices which have fallen more than 30 percent since the 2006 peak are causing a vicious cycle of foreclosures. Housing is also seen as a driver of a recovery in the U.S. economy which is hanging in a delicate balance between growth and a deeper recession.

“The interest rate rise this week is very troubling for the housing market,” said Ronald Temple, co-director of research at Lazard Asset Management in New York. “It raises the cost of purchasing a home at precisely the time when we have large excess supply of homes hitting the market.”

The surge in 30-year mortgage rates to as high as 5.5 percent this week from 4.875 percent a week ago doused refinancing activity by homeowners who had been making applications at their fastest pace since 2003, brokers said.

A bond market rally on Friday softened the blow, but the magnitude of the mortgage rate spike this week could mean record low rates near 4.5 percent seen earlier this year will not be seen again.

Many American homeowners may have been caught by surprise, having been told for months that the Fed would keep interest rates low. Some, perhaps with unrealistic expectations that rates would dive to 4.0 percent, are “freaking out” since they feel they missed the opportunity, said Bob Moulton, president of Americana Mortgage Group in Manhasset, New York.

“If people had let their (prospective) rate float because they thought rates were going lower, or their bank was taking a lot of time to approve a loan, it’s been mayhem,” he said.

The rise in rates to 5.5 percent leaves half of U.S. mortgages with at least a 0.4 percentage point incentive to refinance, down from about 90 percent when rates were at 5.0 percent, said Scott Buchta, a strategist at Guggenheim Capital Markets in Chicago.

Rates on 30-year fixed home loans soared this week as concerns of rising U.S. government debt yields increased investors’ risks of owning mortgage-backed securities.

The worry offset a so far successful program by the Federal Reserve to lower mortgage costs through weekly purchases of more than $20 billion in mortgage backed securities (MBS) since mid-March.

The Fed has spent more than $500 billion of its pledge to buy up to $1.25 trillion of the securities in total.

Analysts now assert the Fed will have to get more aggressive to hold rates down, perhaps by boosting purchases of U.S. Treasury securities in an effort to reduce those yields which are a benchmark for home mortgage calculations.

Such a further move by the Fed could have a counterproductive effect on mortgage rates though.

Investors this week worried that Fed MBS and Treasury purchases will expand the money supply and fuel faster inflation and so they have demanded higher yields. Accelerated Fed buying may only feed that cycle, said Thomas Lawler, founder of Lawler Economic & Housing Consulting in Leesburg, Virginia.

“The Fed can’t really control long-term interest rates,” Lawler said. “It can have short-term effects, but if it is buying Treasuries by creating money, they are going to be the only buyer.”

The stakes are high for the housing market, which in fits and starts is trying to extricate itself from a downturn not seen since the Great Depression. One industry report this week illustrated a mixed market, showing sales of existing homes rising but inventories also up and home prices falling.

Interest rate reductions had reduced likely house price declines for the remainder of 2009 to around 20 percent, from 39 percent, according to a Lazard Asset Management estimate before this week’s Treasury and mortgage bond routs.

Home prices fell 7.0 percent in the first three months of 2009, per Standard & Poor’s/Case-Shiller Home Price Indexes.

Fed purchases of mortgage bonds have helped reduce rates between 1.6 and 2.2 percentage points, cutting monthly payments to the typical borrower by 16 percent to 22 percent, Lazard’s Temple said in a research note earlier this week. That savings has since been reduced significantly.

Lower mortgage rates not only increased housing demand but also freed cash for consumer debt reduction or spending.

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