The conventional wisdom is that fence-sitting buyers buy homes in reaction to rising interest rates for fear of being priced out of the housing market. In the past, this has often been the case, mostly because realtors use this scare tactic to generate quick commissions. However, with the credibility of the realtor community at zero, and with so few fence-sitting buyers, the impact will not be to increase buying this time around.
I wrote recently that surging mortgage rates may scare sellers into action. This isn’t the irrational fear of realtors stoking the market, but a very rational realization that the sellers market can’t get any better than it is today, and if sellers don’t take advantage now, they may find it much more challenging to find a qualified buyer who can afford today’s prices in the future.
So what evidence do we have that mortgage interest rates will keep rising? Is the short-term spike in interest rates going to moderate? Will mortgage rates below 4% ever return?
Mortgage interest rates are the inverse of bond prices. As investors bid up prices on mortgage-backed securities, yields and mortgage interest rates fall. When investors sell off these bonds, prices fall, and yields and mortgage interest rates go up. Right now, it looks like the selloff in the bond market will likely continue.
Wall Street never thought it would be this bad.
Over the last two months, and particularly over the last two weeks, investors have been exiting their bond investments with unexpected ferocity, …
A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.
Instead, since the Federal Reserve chairman, Ben S. Bernanke, recently suggested that the strength of the economic recovery might allow the Fed to slow down its bond-buying program, waves of selling have convulsed the markets.
I discussed in detail How the federal reserve’s printing money impacts housing. The upshot is that houses become less affordable, and the higher rates go, the less affordable housing becomes. At first, this causes sales volumes to decline, but if rates move to high too fast, prices will reverse course and head down again.
The selling has been most visible among retail investors, who have sold a record $48 billion worth of shares in bond mutual funds so far in June, according to the data company TrimTabs. But hedge funds and other big institutional investors have also been closing out positions or stepping back from the bond market.
“The feeling you are getting out there is that people are selling first and asking questions later,” said Hans Humes, chief executive of the hedge fund Greylock Capital.
As irrational as that sounds, it’s the wise move in this circumstance. We know bond prices will move lower because the biggest buyer in this market just signaled they were going to stop. It doesn’t make much sense to hold a bond yielding 3% when it will lose 20% or more of its value. Investors can’t make up in yield what they will lose in value.
The money the Fed spends on bonds is supposed to bolster the economy, but the cheap money coming from the Fed has also made it less expensive and easier for investors to make large, increasingly speculative bets on bond prices. …
In the current fear-soaked atmosphere, market participants are looking over their shoulders, seeking to identify which firms or funds are sitting on big losses and might be forced to sell large lots of bonds. The most obvious contenders are those that bought bonds with borrowed money. In Wall Street parlance, that is called leverage. It can magnify returns when rates are low and prices are rising, but unwinding leveraged trades can deepen losses.
“The fact that we’re seeing these violent moves is a reflection that there was leverage there,” George Goncalves, a fixed-income strategist at Nomura, said. “This is definitely more than a hissy fit. Some people are being forced to sell.” …
“It’s a self-fulfilling cycle until everyone gets exhausted,” said Peter Tchir, the founder of TF Market Advisors. “We don’t think we’ve seen the capitulation we need to hit bottom yet.”
If this is a panic move backed by the need to unwind leveraged positions, and if we haven’t seen capitulation yet, the selloff could increase in magnitude and get completely out of control. Rates could spike very high in the short term.
In all likelihood, there will be a relief rally, and some part of the move will be retraced. The move from 3.4% to 4.4% might retrace back to 3.9%, but then it will steady out at around 4.25% for a while before resuming its march higher.
The 30-year fixed rate home loan has jumped a full percentage point above recent record lows, raising borrowing costs and posing a threat to consumer confidence.
Mortgage rates have zoomed a full percentage point above their recent record lows, raising costs for borrowers and questions about the housing recovery.
A standard 30-year fixed-rate home loan hit an average of 4.63% on Monday before backing off just slightly Tuesday, according to HSH Associates. That’s up from 3.49% on May 3 and an all-time average low of 3.44% during a week in December.
Although still low by historic standards, the increased rates have put a damper on a home refinancing boom and will make buying a home noticeably more expensive for borrowers.
With near peak pricing in several OC markets, higher borrowing costs will hurt home sales and slow down house price inflation.
“This is going to undermine that wealth effect that the Fed has been trying to create,” Koesterich said.
Stifling the Ponzi effect is a good thing. HELOC abuse will not be as prevalent this time around.
Homes in Southern California are less affordable, not surprisingly, but that has more to do with skyrocketing home prices than interest rates, Sharga said. Doug Duncan, Fannie Mae’s chief economist, said rapid run-ups in mortgage rates in 1994, and again in late 1999 and early 2000, caused home sales to fall sharply — but didn’t depress prices.
The runup in mortgage rates during those times was short lived. Before prices had a chance to weaken, rates were lowered again, and the market regained its strength. That will probably not happen this time around.
The Fed’s current bond-buying program has no precedent, Duncan said, making it difficult to make comparisons with the current situation.
Duncan said the higher rates would have the immediate effect of pricing certain stretched borrowers out of the market.
And since most buyers in Southern California stretch to the max to buy a house, this will impact almost everyone. Some potential buyers will chose to substitute down to lower-quality housing, but many will just sit tight and see if prices come down again.
It’s not like anyone believes prices only go up anymore.
Sold to the bank at the peak
The former owners of today’s featured property fortuitously timed their refinance. They were not Ponzis, and the only record of mortgage activity after their purchase-money mortgage was a HELOC in 2004 that they may not have used. However, they refinanced with a $406,000 first mortgage on 7/17/2007 and extracted about $175,000 from the property. Like many, many others, this caused them to lose their house.
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Proprietary OC Housing News home purchase analysis
2182 CEDAR Ln Tustin, CA 92780
$529,900 …….. Asking Price
$221,000 ………. Purchase Price
12/7/2000 ………. Purchase Date
$308,900 ………. Gross Gain (Loss)
($42,392) ………… Commissions and Costs at 8%
$266,508 ………. Net Gain (Loss)
139.8% ………. Gross Percent Change
120.6% ………. Net Percent Change
6.9% ………… Annual Appreciation
Cost of Home Ownership
$529,900 …….. Asking Price
$105,980 ………… 20% Down Conventional
4.38% …………. Mortgage Interest Rate
30 ……………… Number of Years
$423,920 …….. Mortgage
$108,250 ………. Income Requirement
$2,118 ………… Monthly Mortgage Payment
$459 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$110 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$109 ………… Homeowners Association Fees
$2,796 ………. Monthly Cash Outlays
($375) ………. Tax Savings
($571) ………. Principal Amortization
$170 ………….. Opportunity Cost of Down Payment
$86 ………….. Maintenance and Replacement Reserves
$2,107 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,799 ………… Furnishing and Move-In Costs at 1% + $1,500
$6,799 ………… Closing Costs at 1% + $1,500
$4,239 ………… Interest Points at 1%
$105,980 ………… Down Payment
$123,817 ………. Total Cash Costs
$32,300 ………. Emergency Cash Reserves
$156,117 ………. Total Savings Needed
The property above is available for sale on the MLS.Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!