Rising Mortgage Rates

There was a great post today from ZeroHedge.com on how rising mortgage rates will effect a borrower’s amount of home they can buy. Furthermore, rising rates may kill what little “recovery” the government says we’re having. Mortgage rates have been very low, but too fast of increase can casue a knee-jerk reaction in the real estate purchase market.

Rising rates mean a collapse in purchasing power. Here is a glimpse of what has happened to the mortgage rates in the past month alone: from Bloomberg’s Jody Shenn:

 Wells Fargo & Co., the largest U.S. mortgage lender, is offering a 30-year fixed-rate mortgage at 4.5 percent, according to its website, up from 4.13 percent on June 18 and 3.88 percent on May 22, when comments by Bernanke to lawmakers and the release of the minutes of the last Fed meeting caused bonds to plummet. Freddie Mac’s survey, which is lagging behind the bond slump because it reflects originator responses through yesterday, showed average rates falling to 3.93 percent this week.

So in one month, the average 30 year fixed rate mortgage has jumped by over 60 basis points. What does this mean for net purchasing power? Well, as the chart below shows, assuming a $2000/month budget to be spent on amortizing a mortgage (or otherwise spent for rent), it means that suddenly instead of being able to afford a $425K house, the average consumer can buy a $395K house.

This means that, all else equal, housing just sustained a 7% drop in the average equlibrium price based on what buyers can afford.

But assuming the current selloff in rates continues, things are going to get much worse: we may be seeing 5%, 5.5% even 6% and higher mortgages in the immediate future.

It also means that a buyer who could previously afford a $506K house with a $2,000 monthly budget at an interest rate of 2.5% will be able to afford only $316K if and when the average 30 Year fixed hits 6.5%: a 40% drop in affordability based on just a 4% increase in interest rates!

And this is bullish for the economy? I think we are going to see a lot of volatility in both the interest rate/mortgage market as well as the stock market for a while.

This entry was posted in Mortgages, News, Real Estate and tagged , , . Bookmark the permalink.