Federal reserve’s taper could trample Coastal California housing

The federal reserve is tapering its purchases of mortgage-backed securities. This may drive up mortgage interest rates and cause housing markets in more sensitive markets like Coastal California to feel pain though lower sales volumes and perhaps lower prices.

If mortgage interest rates go up and incomes do not, borrowers will not be able to borrow enough to support today’s prices. In June of 2013, rising interest rates killed the bubble reflation rally that began in early 2012; prices stopped going up, and transaction volumes declined to levels lower than witnessed in 2012. If mortgage interest rates move even higher, sales volumes will decline further, and it may begin to erode pricing, although a crash is unlikely given the nature of cloud inventory. So what caused the sudden rise in mortgage rates in 2013? Could these same forces push rates higher again in 2014?

Policies in Washington impact housing in many ways. The federal reserve’s direct purchase of mortgage-backed securities, zero-interest-rate policy, quantitative easing (printing money), forward policy guidance, and other measures serve to push mortgage rates down. In fact, mortgage interest rates hit record lows in early 2013; however, the party didn’t last. It’s been said that the federal reserve’s mission is to take away the punch bowl when the party gets started: in May of 2013, then Chairman Ben Bernanke hinted that the federal reserve might slow its ravenous purchases of mortgage-backed securities, and the bond market reacted by selling before the biggest buyer slowed its buying activity. The sudden collapse in mortgage bond prices drove mortgage interest rates from 3.5% to 4.5% in a very short time — and this was on the mere suggestion that the federal reserve might slow its purchases; they still purchased $45 billion per month even while prices collapsed.

In December, the federal reserve announced they really were going to slow their purchase activity. The market didn’t immediately react with another selloff, but those investors most active in this market know that a big buyer is going to taper its purchases, and removing that much demand from the market is not likely to send prices higher. With low bond prices on the horizon, most market watchers believe bond prices will fall, driving mortgage interest rates up; higher mortgage rates will, in turn, hurt the housing market — and it’s the Coastal California housing markets, those which inflated the quickest, that potentially face the biggest problems when the federal reserve tapers its mortgage-backed securities purchases.

Fed taper could hit housing market

Soaring mortgage costs already discouraging local buyers

By Dan McSwain5 p.m.Jan. 18, 2014

The stakes are high for San Diego’s housing market as the Federal Reserve tapers the national economy off super-low interest rates. …

And there’s little question that higher rates would hurt potential homebuyers. Already, skyrocketing mortgage payments may have chased away enough demand to halt price growth.

Further increases would pile a new problem onto the region’s housing market, which is distorted by a chronic supply shortage and soaring costs caused by local and federal government polices.

While I agree there is little question higher rates will hurt potential homebuyers (See: Future housing markets will be very interest rate sensitive), many housing market bulls completely dismiss such concerns because the percentage of all-cash buyers is so high. Housing bulls argue that mortgage rates don’t matter to those who don’t borrow money to buy a house. While there is some validity to that argument over the short term, what happens when all-cash buyers stop? At some point, financed buyers must regain control of the market, and when they do, prices will only rise as high as mortgage interest rates will allow.

Waiting has certainly punished potential buyers lately. A typical new mortgage in San Diego County hit a modern low of $1,150 a month in February 2012, but by last month it had jumped nearly 47 percent to $1,695.

Most of the increase came from home prices, which surged 38 percent in less than two years.

Last summer the action shifted to interest rates, which have climbed from 3.5 percent to nearly 4.5 percent for the average fixed-rate, 30-year mortgage. That run-up started in May, when Fed Chairman Ben Bernanke outlined his plan to gradually reduce bond purchases the central bank began in September 2012 to keep rates low.

Maybe it’s a coincidence, but San Diego’s soaring housing market leveled off at almost precisely the same time.

The median price has inched up less than 1 percent since June, when it was $416,500, to $420,000 in December, according to DataQuick, a San Diego-based reasearch firm.

In contrast, the median had shot up 36 percent before the announcement from $305,000 in February 2012, when the typical payment reached its low. …

It’s no coincidence house prices stopped rising when interest rates went up. There is a direct cause and effect; buyers were unable to raise their bids.

On the bright side, many experts see little risk that interest rates will skyrocket as they did in the early 1980s, when the Fed cranked up rates to tame high inflation. Indeed, Bernanke has warned that inflation is too low.“I would tell people not to panic on interest rates; they aren’t going to be going up very much,” said Christopher Thornberg, founding partner of Beacon Economics in Los Angeles. “We have a world that is awash with capital, and not much demand for it for a variety of reasons.”

Bernanke has said the Fed will effectively be stimulating the economy until it stops buying bonds completely and begins to raise short-term interest rates, probably not before 2015 or beyond.

His successor, Janet Yellen, shares that view. Both are worried about inflation, which slumped to 0.7 percent in October, well below a 2.5 percent target.

I agree. In today’s economy, a sudden surge of interest rates doesn’t seem very likely.

Thornberg also predicts rising prices, even as he warns that the shortage poses a serious threat.“If you think about the California economy, and what is holding back growth right now, it has to do with a high number of people leaving the state because housing is unaffordable,” he said.

Rising mortgage rates will make housing even more unaffordable; apparently, despite the problems it causes the State, everyone in California bawls for higher house prices. Can’t live without that ATM machine, you know.[dfads params=’groups=165&limit=1′]

In previous market cycles, an uptick in mortgage rates has caused a spurt of sales activity, as potential buyers jump off the fence to lock in low rates.

This time such demand might not materialize. … early this month regulators released the new rules — which raise fees and expose lenders to lawsuits for many of the jumbo or adjustable-rate loans common in high-cost areas such as California.

So even if interest rates stay tame for years, borrowers face higher costs and fewer loan options. …

In the past, California could count on lenders to come up with some innovative loan program to push prices higher and distribute free money to homeowners to stimulate the economy through reckless spending. The housing ATM machine will not be running at peak efficiency for a while.

In the past, California could count on a rapidly growing economy to generate abundant high-paying jobs so new buyers would have to compete for available housing stock and push house prices higher. With the outflow of talented people caused by unaffordable house prices coupled with a business unfriendly State Government, the rapidly expanding growth machine will not be running at peak efficiency for a while either.

Given the realities of the situation, the federal reserve’s taper could trample Coastal California housing.

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[idx-listing mlsnumber=”OC14014324″]

5498 PASEO DEL LAGO East Unit P Laguna Woods, CA 92637

$389,900 …….. Asking Price
$140,000 ………. Purchase Price
6/22/1988 ………. Purchase Date

$249,900 ………. Gross Gain (Loss)
($31,192) ………… Commissions and Costs at 8%
$218,708 ………. Net Gain (Loss)
178.5% ………. Gross Percent Change
156.2% ………. Net Percent Change
4.0% ………… Annual Appreciation

Cost of Home Ownership
$389,900 …….. Asking Price
$13,647 ………… 3.5% Down FHA Financing
4.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$376,254 …….. Mortgage
$128,856 ………. Income Requirement

$1,886 ………… Monthly Mortgage Payment
$338 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$81 ………… Homeowners Insurance at 0.25%
$423 ………… Private Mortgage Insurance
$600 ………… Homeowners Association Fees
$3,329 ………. Monthly Cash Outlays

($422) ………. Tax Savings
($504) ………. Principal Amortization
$22 ………….. Opportunity Cost of Down Payment
$69 ………….. Maintenance and Replacement Reserves
$2,494 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$5,399 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,399 ………… Closing Costs at 1% + $1,500
$3,763 ………… Interest Points at 1%
$13,647 ………… Down Payment
$28,207 ………. Total Cash Costs
$38,200 ………. Emergency Cash Reserves
$66,407 ………. Total Savings Needed
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