What Rising Rates Mean for the Mortgage Market

Photograph by Stefan Schmid/Gallery Stock

The refi boom may be coming to an end. Since the Federal Reserve began pushing down rates in early 2009, refinancing has accounted for more than half of all new mortgages and in some periods has represented almost 80 percent of all new loans. Now, with the economy slowly recovering and the Fed considering pulling back its efforts to keep interest rates low, rates are climbing. Mortgage rates rose above 4 percent last week for the first time in more than a year, sending refi applications down to their lowest level since November 2011.

Refis have been a cash cow for banks. In a note out today, Moody’s analyst Megan Snyder says fewer refis means banks will see less revenue, both because volume is down and because margins are shrinking. How banks respond to rising rates changes the game for borrowers.

For a while, many banks will absorb some of the impact of rising rates by reducing how much profit they make on each loan. Their margins on mortgages reached record highs in 2012, so they have room to trim them to keep business coming in and still be making money. “In the short term, everybody will be playing a game of chicken to see if rates go back down,” says FBR Capital Markets analyst Paul Miller.

If rates don’t go down soon, banks may start laying off staff from the huge operations they built up to process the refis. Compass Point’s Kevin Barker says this will be especially true for smaller lenders, who will have to choose if they focus their staff and capital on other types of lending, such as business loans or credit cards.

That same quest to replace refi revenue could lead banks to be more lenient in approving new mortgages for buying homes. “In a lower-volume environment, given the capacity out there, you will see some people loosening up credit,” Miller predicts. He says banks won’t lower standards as much as they did in the housing bubble. The average FICO scores for new loans could drop from about 750 to as low as 710, he says. Making mortgages somewhat easier to get would help the housing market rebound—which could help the economy and further push up rates.

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