A sharp rise in mortgage rates is threatening to slow the momentum that has driven the housing market sharply higher in the past year.
Rates on a 30-year fixed mortgage have spiked in the past two months as the Federal Reserve signaled the coming end of a massive bond-buying program designed to stimulate the economy by keeping rates low.
Someone who today takes out a $220,000 loan — the median sale price for a traditional home in the Twin Cities — will pay at least $100 per month more on the mortgage than someone who locked in an interest rate on May 1.
“It’s been a pretty impressive increase in rates,” said Keith Gumbinger, vice president of HSH.com, a mortgage information firm. “If that increases monthly payments by, give or take, 10 to 15 percent, it wouldn’t be unreasonable to see sales back off by perhaps that much.”
U.S. home prices were up 12 percent in May from a year earlier, and Twin Cities prices were up 14.8 percent, in part thanks to demand fueled by rock-bottom interest rates. Since home purchases often translate into sales of garden hoses, lawn mowers and washing machines, as well as construction jobs, the likelihood that rates will continue to rise should temper economic growth.
The irony is that what’s driving up rates is, ultimately, an improving economy. Rates are as low as they are because the Federal Reserve has been buying $85 billion in mortgage-backed securities per month, a program known as quantitative easing that’s meant to stimulate borrowing.
The Fed’s purchases create demand for mortgage-backed securities and so drive down interest rates for borrowers. The strategy has been effective. Rates for 30-year mortgages were as low as 3.3 percent in November, a number that inspires awe in anyone who took out a mortgage in decades past.
But rates started to rise in mid-May when Fed Chairman Ben Bernanke first hinted in a Congressional hearing that the economy might be strong enough for the central bank to contemplate slowing its asset purchases. After a Bernanke news conference on June 19, rates on a 30-year fixed mortgage rose from 4 percent to 4.6 percent in five days, while the stock market faltered.
Since then, several regional Fed presidents have tried to soothe the markets by saying they will move slowly and only if unemployment keeps falling.
“Mr. Bernanke did take pains to say that the Fed will adjust its policies and its purchases relative to the strength of what’s happening in the economy, in terms of jobs, in terms of inflation,” Gumbinger said. “To the extent that we do slow down due to this rise in interest rates, it seems very likely that the Fed’s withdrawal from buying mortgage-backed securities and buying Treasurys will become a more protracted process, rather than something that’s immediate and abrupt.”
The effect of higher mortgage rates wasn’t evident in May home sales figures and won’t be in the June figures either, since people generally lock in rates a few weeks before closing on a home.
4.5 percent still is quite low
Keenan Raverty, a vice president at Bell Mortgage and president-elect of the Minnesota Mortgage Association, said higher rates will have an impact on the housing market, though by historic standards 4.5 percent is nothing to panic about. As recently as 2008, rates on a 30-year mortgage were over 6 percent. In 1990 rates were over 10 percent and in 1982 they were over 17 percent, according to Freddie Mac.
“The recent shift in the rates has impacted some people, but it’s not like this represents a high-rate environment,” Raverty said. “This is still a great time to buy a home, and I think there are many smart consumers who know that to be the case.”
And if rising rates mean the Fed is growing more confident about the American economy, that is preferable to a weak economy and lower rates, Raverty said.
“Most mortgage bankers would rather have a robust and growing economy than historically low interest rates,” Raverty said. “The fact that people seem to be going back to work and the economy growing, even slowly, is a positive sign.”
The biggest impact of higher mortgage rates is on refinancing, Gumbinger said. Rates are the only factor in deciding whether to refinance a mortgage. When people decide whether to buy a house, rates are just one factor, and not the most important one.
New buyers must have a job, income, savings and decent credit. They also must have careers and personal lives that make home-buying sensible, and they need to find a home they like in a neighborhood where they want to live. If all those things are in place, a higher interest rate likely won’t deter them.
‘It’s time to do it’
“Am I unhappy that it costs a little more?” Gumbinger said. “Probably a little unhappy, but everything else is aligned, so it’s time to do it.” Meanwhile, mortgage bankers, investors and economists are watching the Fed closely to see how it will unwind quantitative easing. Investors have become more accustomed to the idea of the end of the program, which is why mortgage rates have stopped rising in recent days, Gumbinger said.
But the end of quantitative easing is coming. The questions now are when, and how quickly, Gumbinger said.
In one sense, the mortgage market’s reaction to the Fed is evidence that the central bank is doing its job well, said Pete Ferderer, an economist at Macalester College.
The Fed is trying to keep the economy growing without letting inflation get out of control. It is promoting expansion when growth is slow, and taking its foot off the gas pedal, as Bernanke says, when things start to grow.
Still, the scale and impact of the Fed’s policies in recent years are unprecedented, and seen through the lens of history quantitative easing has been a remarkably ambitious project.
“I’m old enough and I’ve studied enough economic history to be awed by what the Fed has done,” Ferderer said. “It’s become the new normal, that the Fed is going to play such a powerful role in the financial markets.”