Mortgage interest rates may hit new record low
The housing market can’t absorb a sudden or large increase in mortgage rates without major declines in sales and perhaps even decreases in prices.
Congress passed the Dodd-Frank financial reform in response to the housing bubble and bust. These new Dodd-Frank mortgage regulations will prevent future housing bubbles by effectively banning destabilizing loan products with interest-only and negative amortization features. Banning these loans was important because those loan programs enabled buyers to greatly inflate house prices from stable levels set by wages and mortgage rates.
In a stable housing market, the equilibrium price is the highest price consumers can finance, so under pressure to complete more deals, lenders seek ways to increase the size of the loans lenders provide borrowers. Affordability products were born out of this constant market pressure. Unfortunately, while these innovations were welcome at the time, the widespread use of these temporary affordability crutches destabilized the housing market; thus they needed to be banned or regulated out of existence.
Since affordability products were designed and used to solve affordability problems, when interest rates would spike higher, lenders could close deals and sustain sales momentum. After Dodd-Frank, this was no longer the case. In February 2013, before the taper tantrum of May 2013, I wrote that Future housing markets will be very interest rate sensitive due to the lack of affordability products. This was dramatically confirmed when rising rates abruptly ended the reflation rally and again in April 2015 when home sales were pummeled by rising mortgage rates.
This seems intuitively obvious, but many people deny any rising rates causes any problems with housing. Historically, house prices and mortgage rates haven’t correlated well; thus the prevailing view among economists is that the housing market would respond positively regardless of what happens with mortgage rates. Since the market went through significant periods when prices moved in opposition to mortgage rates, and since macro-economists aren’t skilled in deciphering the reasons behind their models, they failed to recognize that the new mortgage rules changed the way housing markets work.
According to the theory I postulated back in early 2013 — prior to the rate surge from 3.5% to 4.5% — rising mortgage rates should cause sales volumes to fall, and falling mortgage rates should cause sales volumes to rise. The restricted inventory may cause prices to go up, but the changes in affordability caused by mortgage rate fluctuations would necessarily impact sales volumes by pricing out (or pricing in) marginal buyers.
In October of 2013 after the sudden mortgage rate spike pummeled sales, I wrote about the mounting evidence of the market’s sensitivity to mortgage rates. The mechanisms used to inflate previous bubbles — using teaser rates, allowing excessive DTIs, and abandoning amortization — these were banned by the new residential mortgage rules. Lenders can’t soften the impact of interest rate fluctuations or provide “affordability” when the market reaches its friction point. This is the main reason the market changed so dramatically and so suddenly when mortgage rates surged.
The sensitivity of the housing market to changes in rates is remarkable, and it’s one of the many reasons I didn’t believe the federal reserve would raise interest rates (more than 1/4) in 2015 because if mortgage rates rise, house prices might drop.
While so-called experts may disagree on what happens, as it turns out, ordinary citizens possess basic math skills, and they are concerned about what will happen to their ability to borrow and buy homes at today’s prices.
Lorraine Woellert, July 22, 2016
Mortgage rates rose for the second week, averaging 3.45 percent for a 30-year, fixed-rate loan, up from 3.42 percent the week before. A year ago, rates averaged 4.04 percent, according to Freddie Mac’s weekly survey.
Despite the uptick, rates have held below 4 percent since December, tying a 29-week run of cheap borrowing we had from November 2014 to June 2015.
During that sprint, the cost of a 30-year loan averaged 3.77 percent. This time, it’s held to 3.64 percent.
Interesting that nearly everyone was certain mortgage interest rates and other rates would rise when the federal reserve raised the base rate. So far, the opposite has occurred, and these low mortgage rates are spurring the housing market in 2016.
Home loans are cheap by any standard. That’s good news particularly for young and first-time buyers, who tend to be more sensitive to cost. Even though they’ve never lived in a high-rate environment, millennial homebuyers still fret about mortgages . Peak millennials — the biggest cohort, born in 1990 — turned 25 last year. They’ve barely witnessed 4 percent rates.
In a Redfin survey, 47 percent of all buyers said they’d look for a less expensive house if rates rose by a point or more. Among respondents 34 and younger, the share was more than 50 percent. Five percent of millennials said they’d give up looking for a house altogether if rates jumped.
Rates are lower now than they were in May, when the survey was taken. That’s one reason June was one of the most competitive months on record for home sales, according to Redfin data.
Mortgage rates will tick up and down week to week, but they’ll stay low for the foreseeable future.
“We don’t expect any significant movement in mortgage rates in the near term,” Freddie Mac chief economist Sean Becketti said. “This summer remains an auspicious time to buy a home or to refinance an existing mortgage.”
When something goes on for a long time, particularly something the defies previously accepted truths, eventually people come to believe it will go on forever. Everyone thought the economic prosperity of the 1920s would go on forever. Few foresaw the stock market crash of 1929 and the Great Depression of the 1930s. Investors and economists are particularly prone to this problem, often projecting short-term trends to infinity.
For the last several years now, pretty much everyone predicted interest rates would rise. Year after year, we were told mortgage rates would rise to 5% and then to 6% shortly thereafter. Every year the pundits were wrong.
In January I wrote that Mortgage interest rates may not go up, housing may prosper in 2016. Like many others who expected interest rates to rise, I’m starting to come around to the idea that low mortgage rates may be with us for a very long time. In fact, I now believe mortgage interest rates can’t go up unless we have a huge increase in demand for housing, which doesn’t seem likely any time soon.
Perhaps I am wrong, and my acceptance of low rates is the capitulation signalling the bottom of the market. I could be just as wrong as Irving Fisher and John Keynes were during the booming 20s. Only time will tell.