Rising Mortgage Rates Are the Least of Buyers' Worries

Photograph by Albert Mollon Close

Photograph by Albert Mollon


Photograph by Albert Mollon

Ben Bernanke and the Federal Reserve have pretty much signaled last call at the Bar of Insanely Low Mortgage Rates. With the Fed now on record that it may begin to reduce its bond-purchasing program by the end of this year -- suggesting the beginning of the end of repressed rate -- the interest rate on a 30-year fixed-rate mortgage hit 4.25 percent on June 20. As recently as early May that same rate was at 3.5 percent.

Keith Gumbinger, vice president at mortgage information website HSH.com, expects the quick rate increase to put a fork in the refinancing market, which currently accounts for more than two-thirds of all new loan activity. After five years of record low rates, most homeowners have already refinanced at least once; the average rate on outstanding mortgages is below 5 percent. When the interest rate on a 30-year loan was at 3.5 percent back in early May, serial refinancers could still make the math work on doing another deal. Not now.

For potential home buyers, though, the recent rate spike is far from mortgageddon. Sure, 4.25 percent isn’t as sweet as 3.5 percent, but it's still downright cheap. Gumbinger points out that the lowest rate in normal times (i.e. times of no Fed intervention) was 5.24 percent in June 2003. “Is the bottom past? Probably. But we’re still well below the historic low,” says Gumbinger.

Wallet Impact

Nor is the wallet impact of higher rates a deal breaker. For every $100,000 in home price, today’s higher rate adds about $40 or so a month to the cost of a 30-year fixed-rate mortgage, compared to when a 30-year fixed-rate was at 3.5 percent. So if you’re looking at a $250,000 home with a 20 percent down payment you’re talking about an $80 increase in your monthly mortgage payment.

Furthermore, housing remains very affordable. Yes, the Case-Shiller national home price index is up 10 percent year over year (through March). But it is still 28 percent below its all-time high in 2006.

An analysis based on the standard approach to measuring affordability -- a mortgage payment that's no more than 25 percent of pre-tax monthly income -- puts things in perspective. A recent report out of Harvard's Joint Center for Housing Studies shows that households could afford the mortgage payment on the median-priced home in 95 percent of metro areas in 2012. Rocio Sanchez-Moyano, a research assistant with the Center, calculated that even if the 30-year fixed-rate rose to 5 percent, 93 percent of metro areas would still fall into the affordable range.

Buy vs. Rent

Then there’s the rental argument for buying. Jed Kolko, chief economist at real estate search site Trulia, recently tapped into his firm’s database to crunch numbers on asking prices for homes-for-sale and rentals in the largest metro areas. For a household that makes a 20 percent down payment, intends to stay in the home seven years and will deduct their mortgage interest and property tax at the 25 percent tax bracket, buying is cheaper than renting as long as the 30-year fixed-rate mortgage is below 10.5 percent.

That 10.5 percent bar is the national average for when buying makes more financial sense than renting. In higher-cost areas, the tipping point for when renting wins out over buying comes earlier. In San Francisco and Silicon Valley Kolko estimates it is at 5.2 percent to 5.4 percent. For New York City and the surrounding metro area, buying remains the better deal up to a 6.8 percent rate on a 30-year fixed-rate mortgage. The tipping point in Los Angeles and San Diego is 7.5 percent.

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We’re a long way from that and not likely to see much higher rates anytime soon. Greg McBride, senior financial analyst at Bankrate.com, says the recent 0.75 percent jump in the 30-year fixed-rate “is the bulk of the move” to expect in response to the potential year-end shift in Fed policy. “We’ll probably see rates stabilize from here, and if anything, they could pull back a little.”

Matthew Graham, mortgage strategist at Mortgage News Daily, notes that a pullback in rates is common after such a sharp, sudden rise. If economic data in coming months continues to tip the Fed toward tapering sooner rather than later, that reduces the odds that mortgages rates will fall back to lower levels. Graham says the next big data point to watch for is the July 5 employment report. “There’s just no way for anyone to know what is going to happen,” says Graham.

The Bigger Issue

For all the attention on mortgage rates, the potentially bigger issue is the impact of sharply rising home prices. The $208,000 national median price for existing homes in May was 15.4 percent higher than last May, according to the National Association of Realtors. “I'm more concerned about the run-up in prices that increases [mortgage] payments, more than the increase in rates,” says Joe Parsons, senior loan officer at PFS Funding in Dublin, California.

There’s not much on the horizon to derail price momentum. If anything, the uptick in rates and the Fed’s signaling increases the resolve of potential buyers to get a deal done sooner than later. That’s not getting any easier as the five-month inventory of homes for sale remains below norm. The National Association of Realtors reported May inventory was 10 percent lower than a year ago. For house hunters facing stuffed-to-the-gills open houses and competing against multiple bidders, the prospect of a slightly higher mortgage payment is the least of their worries.

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