May222015

April 2015 home sales pummeled by rising mortgage rates

If mortgage rates are allowed to rise, the spring 2015 housing rally will be canceled.

Back in February of 2013 when mortgage rates were near record lows, I wrote that future housing markets would be very interest-rate sensitive, despite assurances to the contrary from most macro-economists.

The prevailing economic view is that the housing market would respond positively regardless of what happens with mortgage rates because house prices in the past have correlated poorly with mortgage rates. For example, during the 1970s, interest rates rose significantly, which should have caused house prices to drop, but instead California inflated a housing bubble. During the crash from the bubbles in the 1990s and the 2000s, interest rates declined, and so did prices.

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.

home-sales-mortgage-rates

The sensitivity of the housing market to changes in rates is remarkable, and it’s one of the many reasons I don’t believe the federal reserve will raise interest rates (more than 1/4) in 2015 because if mortgage rates rise in 2015, house prices might drop.

For further evidence of this sensitivity, I bring to your attention the recent 4-week rise in mortgage rates and the unexpected decline in home sales during the prime selling season.

Mortgage rates climb for 4th week in a row

By Janna Herron • Bankrate.comsurpassing_expectations

The benchmark 30-year fixed-rate mortgage rose to 4.03 percent from 4.01 percent last week, according to the Bankrate.com national survey of large lenders. One year ago, that rate was 4.29 percent. Four weeks ago, it was 3.79 percent, and the rate has increased four weeks in a row.

So what happened with four consecutive weeks of rising rates?

Existing-Home Sales Fell 3.3% in April

By THE ASSOCIATED PRESS, MAY 21, 2015

 WASHINGTON — Sales of existing homes in the United States slipped in April, the National Association of Realtors said on Thursday. … The Realtors group said that sales of existing homes fell 3.3 percent to a seasonally adjusted annual rate of 5.04 million. … Sales levels dropped in the Northeast, South and West ….

Nobody expected this.

realtors will desperately spin this bad data, but since rates are now back above 4%, I don’t expect a big surge in sales in May either.

Higher mortgage interest rates lead to lower sales or lower prices, but most likely, lower sales. Mortgage rates fell from mid 2010 through early 2013 just to maintain a low level of demand. When interest rates went up, in what was supposedly a strong market recovery, demand immediately dropped off. It declined through this March, but April’s numbers are a significant setback.

purchase_apps_mortgage_rates_2011-2014

And it isn’t like demand was relatively strong in mid 2010 when it dropped to a 13-year low then stayed there for four years.

MBAApr22014

And this despite a continually rising US population.

Purchase Index and US Population

It’s harder to smooth out interest rate fluctuations

With the normal mechanisms for smoothing out interest rate fluctuations banned, house prices and sales volumes will be dictated by the course of interest rates. It’s widely believed mortgage interest rates will continue to rise in the future. I once asked What will a long-term rise in interest rates do to home prices? Based on what happened in April, we can expect sales volumes to plummet when interest rates rise, and if they rise high enough, price pressure will mount. We won’t see a crash without must-sell inventory, but we may see air pockets where prices drift lower as discretionary sellers decide they want to get out.


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