Aug272013

Rising mortgage interest rates negatively impact the housing market

Since interest rates suddenly and unexpected rose nearly 35% in a two-month period, the mainstream media and bullish housing market analysts have been busy assuring everyone that rising interest rates would have little or no impact on efforts to reflate the housing bubble. Since this is what most people want to hear, an eager public readily accepted the market spin.

Unfortunately, early signs are that rising interest rates are negatively impacting the housing market — just as anyone with common sense would think they would. Is it rational to think that raising the cost of any commodity 35% in two months would not impact sales? And for financed buyers, particularly those using FHA financing putting only 3.5% down, a 35% rise in mortgage interest rates translates into a significant increase in the cost of ownership. As one would expect, this will hamper first-time homebuyers the most as they are the ones most likely to use FHA financing.

FHA Loan Applications Plummet 49% in June

Applications for FHA single-family loans dropped off a cliff in June as a regressive mortgage insurance policy kicked in early in the month and potential borrowers were dealing with rising mortgage rates.

In a monthly loan production report issued Friday, the Federal Housing Administration reported that loan applications fell nearly 50% in June from the prior month.

The new report shows that FHA applications fell to 93,700 in June from 182,400 in May. Applications for FHA purchase mortgage loans fell to 57,650 in June, down 43.5% from the prior month.

That is a huge drop, but mortgage interest rates were not the only factor.

The drop was accentuated by a spike in May applications as borrowers rushed to avoid the June 3 implementation date of a new policy that makes FHA loans more expensive longer-term. Going forward, the annual premium on new FHA loans can no longer be canceled when the LTV ratio hits 78%. FHA borrowers must pay a 1.35% annual premium over the life of the loan. (With private MI, the annual premium is cancelable.)

This makes FHA financing very undesirable. Most people became accustomed to refinancing every couple of years, so many won’t grasp the problem this creates. In a falling interest rate environment, refinancing can get you out of a bad loan, but in a rising interest rate environment, the borrower is stuck. It makes no sense to finance out of a 3.5% FHA mortgage into a 5% conventional. The savings from eliminating the FHA fees will be more than offset by the higher interest rate.

FHA application volume has been very volatile this year.

On April 1, FHA raised the annual premium 10 bps to 1.35%. And loan applications filed in April fell to 118,200 from 221,600 in March.

If you consider the combined effect of these changes and higher interest rates, FHA mortgage applications are down almost 75% from 221,600 in March to 57,650 in July. Now that’s falling off a cliff.

FHA has increased premiums five times over the past two years and “we are clearly at a tipping point here,” Galante testified. “If we increase them more, we would actually shut out additional homebuyers,” she testified.

That boat already sailed. Between the higher fees, higher interest rates and higher prices, many first-time homebuyers are priced out of home ownership. This explains much of why the first-time homebuyer rate has fallen from 40% to 29%.

Dour July Sales Might Cool New-Home Prices

By Kris Hudson — August 25, 2013, 5:10 PM

… To be sure, the July figures didn’t cheer many people. The Census Bureau reported that July sales of new homes amounted to a seasonally adjusted 394,000, down by 13.4% from the revised June rate of 455,000 … The 13.4% sequential decline was greater than most who track the housing industry expected.

The chart below compares the long-term rate of household formation to the level of building activity. Note the decline over the last several months on both.

Most analysts pointed to rising interest rates as the leading culprit,… The rate for a 30-year, fixed-rate mortgage stands at 4.58%, up from 3.59% two months ago.

Mark Zandi, chief economist at Moody’s Analytics, called the July decline “worrisome” for the broader economy. “The question is whether (home buyers) are going to adjust to the higher mortgage rates or just go away,” Mr. Zandi said. “I’m hopeful that buyers are just trying to wait and see where rates will shake out before they sign on the dotted line. But it needs to be watched.”

What really annoys me is that this question was answered by everyone. There was an emphatic refrain from economists, housing market analysts and financial reporters proclaiming that rising mortgage interest rates would have no impact on the housing market (like this one: Home prices across the US defy gravity, despite rising rates). But here we are.

The impact of rising rates has hurt first-time buyers the most, many economists and analysts say, because they are more sensitive to increases in monthly mortgage payments than are more established buyers looking to purchase their second- or third-generation home. The National Association of Realtors has reported that first-time buyers accounted for 29% of purchases in the past year, compared to their typical rate of 40% in past years.

Prior to the spike in interest rates, the most affordable markets were appreciating the fastest. This was due to a combination of all-cash investors and first-time buyers fighting over limited inventory. With prices high enough that hedge funds are losing interest, they are also too high for many first-time homebuyers to afford. Sales volumes and rates of appreciation should drop off significantly in many of these sub-markets over the next few months.

This year, new-home prices have risen partly because of a lack of lots ready for residential construction. In addition, some builders have “metered” sales, meaning they have intentionally limited their output of new homes to reap better profits as long as demand pushes prices higher. Now, with interest rates rising and sales dipping in July, builders likely will feel pressure to rein in prices to keep people buying.

The Irvine Company is masterful at this ploy. If prices go down, they stop building.

“Maybe a little,” said David Crowe, an economist with the National Association of Home Builders. “The problem has been that (builders) are being forced to raise prices because they’re paying more for their ingredients. To the extent that is beginning to taper, I the builders also can afford to modify the increases they’ve had so far.”

Nonsense. Builders raise their prices because they can. It is fallacious economic thinking to believe costs drive finished goods product prices. Demand drives prices. If the costs escalate to where producers can’t make a profit, then they stop producing. If there is sufficient demand, prices will rise and they will start producing again. The idea that cost inputs is what drives builders to raise their prices is nonsense. It’s a weak cover story for builders responding to demand and raising prices to make more profits. Apparently, Mr. Crowe (who knows better) doesn’t think it politically correct to tell the truth in this instance.

Prices “still will go up, but they might not go up at the same pace,” he added. …

“In the last 45 days, (rates) went up quickly enough that people said, ‘Wait a second, what is this?’ ” Mr. Bowman said. “If they were going to come out in the summer, they’re now going to come out in the fall because they figure the train has left the station on low rates.

I believe he is right. I believe many unsatisfied buyers will become active again this fall and winter.

My belief is that there is a general consensus that while (rates have) run up they’re not going to do so again.”

Really? Why? Other than taking brief rests to consolidate, the bond market selloff will likely continue. Perhaps rates won’t rise as quickly as they did in May — a 35% jump in six weeks is rare and remarkable — but we have no reason to believe rates will stay where they are. They might go up, or they might go down, but given the circumstances and investor sentiment, bond prices will keep falling and rates will more than likely continue to rise. It was recently reported that Mortgage rates hit two-year highs on Fed taper talk. What reason to we have to believe this trend will abate?

July existing home sales are up. Why?

Why are existing home sales rising while mortgage applications are falling and new home sales are tanking? It’s a matter of the timing of reporting.

The mortgage application data is compiled each day, so the data is near real-time. New home sales are reported when contracts are signed, so we have this information within 15 days of the end of the previous month. Existing home sales are not reported until the close of escrow. The deals closed in July were put into escrow in May and June. This sales activity in July and August that will be impacted by the higher rates won’t be reported for another 30 to 60 days. Be prepared for headlines about existing home sales also dropping off. Some of this will be seasonal, and the MSM will undoubtedly dismiss the entire decline as seasonal, but if the number is larger than a normal seasonal variation, which it will be, the drop will be due to rising interest rates.

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7 GARDENIA St Ladera Ranch, CA 92694

$620,000 …….. Asking Price
$956,000 ………. Purchase Price
3/28/2006 ………. Purchase Date

($336,000) ………. Gross Gain (Loss)
($49,600) ………… Commissions and Costs at 8%
============================================
($385,600) ………. Net Gain (Loss)
============================================
-35.1% ………. Gross Percent Change
-40.3% ………. Net Percent Change
-5.7% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$620,000 …….. Asking Price
$124,000 ………… 20% Down Conventional
4.61% …………. Mortgage Interest Rate
30 ……………… Number of Years
$496,000 …….. Mortgage
$147,426 ………. Income Requirement

$2,546 ………… Monthly Mortgage Payment
$537 ………… Property Tax at 1.04%
$433 ………… Mello Roos & Special Taxes
$129 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$163 ………… Homeowners Association Fees
============================================
$3,809 ………. Monthly Cash Outlays

($567) ………. Tax Savings
($640) ………. Principal Amortization
$214 ………….. Opportunity Cost of Down Payment
$98 ………….. Maintenance and Replacement Reserves
============================================
$2,913 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$7,700 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,700 ………… Closing Costs at 1% + $1,500
$4,960 ………… Interest Points at 1%
$124,000 ………… Down Payment
============================================
$144,360 ………. Total Cash Costs
$44,600 ………. Emergency Cash Reserves
============================================
$188,960 ………. Total Savings Needed
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