Feb282017

Rising mortgage rates since Trump’s election already slowing home sales

Since the mid 1990s, mortgage interest rates and home sales moved in opposite directions. Dodd-Frank made this inverse correlation even stronger.

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 macroeconomists. Last year I noted that fewer home sales or lower prices was sure to follow higher mortgage interest rates. Generally, volume precedes price, and as one would expect, the recent spike in mortgage rates is already hurting sales.

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.

However, after the housing bubble from the late 80s petered out in the mid 90s, housing markets began to show a strong inverse correlation between interest rates and sales. If interest rates went up, sales went down, and visa versa.

Federal-Funds-Rate-Home-Sales-Volume 2

Since the new mortgage rules changed the way housing markets work, the housing market today displays more sensitivity to fluctuations in mortgage rates than before.

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 decrease sales volumes and declining mortgage rates should increase sales volumes. 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 fail to soften the impact of interest rate fluctuations or provide “affordability” when the market reaches a friction point, which is the main reason the market changed so dramatically and so suddenly when mortgage rates surged in 2013.

home-sales-mortgage-rates

The sensitivity of the housing market to changes in rates is remarkable. As the two charts above demonstrate, the inverse correlation began to take hold in the mid 1990s, and the passage of Dodd-Frank made the inverse correlation even stronger because lenders can no longer evade the underlying math.

Pending home sales drop unexpectedly to lowest in a year, down 2.8% in January

Diana Olick, February 27, 2017

Higher mortgage rates and near record low supply resulted in disappointing home sales to start the year.

House hunters signed 2.8 percent fewer contracts to buy existing homes in January compared with December, although December’s read was revised slightly higher, according to the National Association of Realtors.

Pending sales are nearly always higher in January than December. Fewer people shop for homes in December than in any other month, and the last two weeks are lost to the holidays. Usually, January picks up from December, and February improves over January, the so-called Super Bowl effect. If pendings are down again in February, then the rise in mortgage rates signifies real trouble.

The group’s so-called pending home sales index is now just 0.4 percent higher than January 2016, and this is the lowest reading since then. Pending home sales are an indicator of closed sales in February and March.

Only the NAr failed to expect this. Anyone who understands how sensitive home sales are to mortgage rates would anticipate this decline.

“The significant shortage of listings last month along with deteriorating affordability as the result of higher home prices and mortgage rates kept many would-be buyers at bay,” said Lawrence Yun, chief economist of the NAR. “Buyer traffic is easily outpacing seller traffic in several metro areas and is why homes are selling at a much faster rate than a year ago. Most notably in the West, it’s not uncommon to see a home come off the market within a month.”

Blaming the lack of inventory is a tired excuse Yun falls back on whenever sales are down. The inventory problem has been with us for years, and it will continue to be a problem. However, it never seems to be a problem when sales are up, but when they are “unexpectedly” down, then Yun resorts to this lame excuse.

Mortgage rates moved sharply higher after the presidential election and have remained elevated ever since. Home price gains continue to increase with the weaker supply, clearly weighing on affordability. Experts had expected a slight gain for pending home sales, as new supply was expected to come onto the market in January. …

“January’s accelerated price appreciation is concerning because it’s over double the pace of income growth and mortgage rates are up considerably from six months ago,” said Yun. “Especially in the most expensive markets, prospective buyers will feel this squeeze to their budget and will likely have to come up with additional savings or compromise on home size or location.”

Many would-be homebuyers voluntarily withdraw from the market because they become dissatisfied with their alternatives. Some potential buyers will accept less, but many others are priced out, which is largely why sales volumes decline when rates rise.

Regionally, … The biggest drop was in the West where sales plunged 9.8 percent for the month and were 0.4 percent lower compared with a year ago.

The new mortgage regulations will prevent future housing bubbles, but we witness the success of these new regulations in a change in housing market behavior: high prices hurt sales volume. Housing economists’ conventional wisdom states that rising house prices creates “escape velocity” as potential homebuyers become more motivated, they compete with one another, and they drive prices higher. The motivation may be there (kool aid is eternal), but the key enablers of this behavior are unable to play along; the new mortgage regulations curtailed affordability products.

When you think about it, sales volumes should decline with higher prices. Basic supply and demand theory says that at higher prices, a lower quantity of any good or service is demanded. For years housing behaved differently due to the credit cycle with affordability products. Now that these products are effectively banned, the housing market behaves as any other market would.

Let’s just hope Trump fails in his efforts to let the Genie back out of the bottle by dismantling Dodd-Frank.