Rising interest rates spoiling efforts to reflate the housing bubble

The banks changed their policies radically in early 2012 and opted for can-kicking loan modifications over foreclosure. Their plan was to dry up the MLS inventory, particularly the distressed properties, and rely on record low interest rates to fuel demand. They were very successful. In fact, they were so successful that price rose nearly 40% in beaten down markets and 20% in stronger markets like those in Coastal California.

Everything was going according to plan. Investors competed with owner-occupant buyers to bid up prices for the limited available inventory. Buyers who couldn’t afford housing bubble prices at 6.5% interest rates prevalent in 2006 could afford those prices at 3.5% interest rates in 2012, despite the tepid income growth during the recession. There was only one problem. Rumors that the federal reserve would taper their money-printing stimulus caused investors in the bond market to head for the exits — stampede actually. The sudden spike in interest rates from 3.5% to 4.5% has left everyone wondering if the banks can succeed in reflating the housing bubble so they can get out from under their bad loans suspended in cloud inventory.

Mortgage rate spike finally hits housing

By: Diana Olick — CNBC Real Estate Reporter — Published: Friday, 9 Aug 2013

A sharp jump in mortgage rates from May to June are now beginning to weigh on the housing recovery. The two-month delay can be attributed to several factors—first and foremost that most potential home buyers lock in mortgage rates early, and sale closings can take up to two months to be finalized.

Second, there may also have been a surge in homebuying because of the rise, as those on the fence suddenly jumped in, fearing rates would continue going up and they would be priced out of the market. Those factors have now expired.

Another phenomenon we saw is the influx of new listings as nervous sellers wanted to cash in before the potential buyers were priced out. (See: Surging mortgage rates may scare sellers into action and Sell now, mortgage interest rates to keep rising)

“We saw an increasing number of comments suggesting the sharp rise in mortgage rates has led to a pause in demand, with many agents saying the initial urgency they saw from buyers as rates moved higher has subsided and now buyers are stepping back to re-evaluate their options,” said analysts at Credit Suisse in their monthly survey of real estate agents. They noted a drop in buyer traffic in July, the first time since last December that it didn’t exceed expectations. …

Many potential buyers must now face the prospect of getting much less house for their money. Many may ultimately choose to buy, but with the cost of ownership rising much faster than rents, many potential buyers may sit back and wait to see what happens. Potential buyers no longer believe the old fallacy that house prices only go up.

“Consumers have taken the interest rate rise in stride. Expectations for continued improvement in housing persist, and sentiment toward the current buying and selling environment is back on track from its dip last month,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “These results are consistent with our own analysis of previous housing cycles, which finds that interest rates and home prices are not strongly correlated.”

Wishful thinking. Perhaps house prices and mortgage rates haven’t correlated in the past, but I discussed that at length in the post Future housing markets will be very interest rate sensitive.

Another survey from home builder PulteGroup found 43 percent of move-up buyers indicating they are planning to buy a new home within the next five years, with 76 percent saying they believe they can sell their current home within the next two years for enough to move up. Pulte targets the move-up buyer.

Another survey full of wishful thinking. (See: The move-up market will suffer for another decade)

Mortgage applications to purchase a newly built home rose 14 percent month to month, according to the Mortgage Bankers Association, but new home buyers may be less sensitive to rates, as builders can buy down mortgage rates as part of the deal.

It all prompts the question: With rates still historically low, does a 1 percentage point jump in rates really matter?

“It absolutely matters,” said Craig Strent, CEO of Maryland-based Apex Home Loans. It does put people that are on the fringes that were just on the edge of qualification—it does kick them out from qualifying. For those that already did qualify, it’s psychological. All of a sudden that house that was going to cost you X, is now costing you another hundred dollars a month in mortgage payments and that does make a difference.”

This is the argument I’ve been making since rates began to rise. Restricting inventory can work wonders, but rising rates reduces the size of the potential buyer pool by pricing out the marginal buyer. This has to have an impact on overall demand. The best evidence of this is the widespread decline in mortgage applications. (See: Mortgage Activity Plunges 50% To April 2011 Levels) Some of this is a sharp decline in refinances, but purchase originations applications are also down.

There is also the question of home prices, which continue to rise because of a severe lack of homes for sale. This varies market-to-market, but is especially severe in formerly distressed markets that were targeted by investors.

“We see many threats to the housing recovery,” said Jaret Seiberg of Guggenheim Partners. “Rising rates will make homes less affordable. We also are concerned that investors have artificially stabilized some markets and driven prices up beyond what consumers can afford at today’s higher interest rates.”

Therein lies the fatal problem for banks. Potential buyers could afford peak prices — which banks must get to pay off their bad loans — when interest rates were 3.5%, but at 4.5% or higher, buyers simply can’t borrow enough money from Peter to pay Paul. Rising interest rates are spoiling the bank’s efforts to reflate the housing bubble.

What will happen next?

Fall and winter are typically characterized by declining inventory and falling prices as sellers who missed the spring rally either take a lower offer or withdraw their houses from the market. If prices pull back over the fall and winter, the year-0ver-year numbers will still look great, so even if prices pull back, that isn’t what the NAr and the MSM will report on. I don’t expect to see much of a pullback because many buyers who still want properties were unable to get one during the spring. Many of these buyers will still be active.

I also don’t expect to see the inventory decline this fall and winter. The number of homes for sale is still well below historic norms, and rising prices have brought out many wouldbe sellers with WTF listing prices that will sit on the MLS for months. I do expect to see sales volumes drop off because investors are not as enthusiastic about higher prices, and the marginal owner-occupant buyer just got squeezed out by the combined effect of rising interest rates and higher prices.

Despite the supposed strength at the high end of the market, when an REO hits the market at $1M+ price points, it still sports a significant discount. Today’s featured property is asking 40% off it’s peak purchase price. Somehow, I rather doubt the competing bids over the ask will push the asking price up that much.

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[idx-listing mlsnumber=”OC13160207″ showpricehistory=”true”]

8366 TERRANOVA Cir Huntington Beach, CA 92646

$1,100,000 …….. Asking Price
$1,827,500 ………. Purchase Price
3/29/2006 ………. Purchase Date

($727,500) ………. Gross Gain (Loss)
($88,000) ………… Commissions and Costs at 8%
($815,500) ………. Net Gain (Loss)
-39.8% ………. Gross Percent Change
-44.6% ………. Net Percent Change
-6.7% ………… Annual Appreciation

Cost of Home Ownership
$1,100,000 …….. Asking Price
$220,000 ………… 20% Down Conventional
4.82% …………. Mortgage Interest Rate
30 ……………… Number of Years
$880,000 …….. Mortgage
$229,556 ………. Income Requirement

$4,628 ………… Monthly Mortgage Payment
$953 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$229 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$120 ………… Homeowners Association Fees
$5,930 ………. Monthly Cash Outlays

($1,503) ………. Tax Savings
($1,093) ………. Principal Amortization
$406 ………….. Opportunity Cost of Down Payment
$158 ………….. Maintenance and Replacement Reserves
$3,897 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$12,500 ………… Furnishing and Move-In Costs at 1% + $1,500
$12,500 ………… Closing Costs at 1% + $1,500
$8,800 ………… Interest Points at 1%
$220,000 ………… Down Payment
$253,800 ………. Total Cash Costs
$59,700 ………. Emergency Cash Reserves
$313,500 ………. Total Savings Needed
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