Market Questions Importance of Mortgage-Rate Rise
August 9, 1999
Despite the fact that rates on 30-year fixed-rate mortgages broke the pivotal 8% mark last week - causing quite a stir in most financial media and prompting certain naysayers to predict the end of a robust housing boom - most Wall Street analysts and housing economists were not worried, confident that the rise in rates got far more attention than it deserved.
"The purchase side of the market has been stubbornly strong all year," said Robert Van Order, chief economist at Freddie Mac. "Though there will be less mortgage product as a result of the higher rates, by all indications, this will still be the second strongest year for mortgage originations."
Similarly, Linda Lowell, director of mortgage research at Credit Suisse First Boston, agreed that the predicted negative implications of the 8% rate were more than slightly overblown:
"I think that news about the death of the housing market is greatly exaggerated," Lowell said. "I think this is sensational excitement."
For sure, the move to an 8% mortgage rate - the highest the rate has been since June 1997 - might slow the home-ownership decision for some prospective buyers.
Particularly for borrowers who are first-time buyers or are on the cusp of the 7.8% category - marginal purchasers who are stretching their pocketbooks to buy a home - a quarter percent interest rate increase can certainly price someone out of the market.
Still, the short-term difference in payments for the average borrower is not likely to impact the decision to buy: on a $100,000 loan, the monthly loan payment is approximately $733.36 for 30 years with an 8% mortgage, said Lowell, which is approximately $34 more than the monthly payment due on a 7.5% loan.
Though that amount can be significant over the span of many years for families on the margin, it is not likely to convince buyers who have been saving to abandon their goal of purchasing a home.
"Would that deter you if you really wanted to have a house?," she said. "I doubt it. Plus, you could always get an adjustable-rate mortgage or a balloon. And it is so easy to refinance the minute things turn around.
"I think there has been a lot of crying wolf here."
Strong Housing Turnover
One of the main indicators that leads mortgage experts to believe that the 8% interest rate will not have as devastating an effect as some predict is the particularly strong rate of housing turnover that currently exists.
"Housing continues to be a good value for investment generally," said Amy Crews Cuts, senior economist at Freddie Mac. "As people are feeling richer, and with all the good economic indicators, that is translating to investments in newer houses, bigger houses, and people who were not in the home ownership part of the economy are now jumping in."
"As long as you have low unemployment, good equity markets, a good overall economy, the effect of this rise in mortgage rates will be much less than in 1994, when the housing market was much weaker," added Jonathan Raiff, a prepayment specialist at PaineWebber. "Home sales are still running above 5 million per annum, and the purchase index is at 293, which is the highest since early July, so you're not seeing a huge drop-off in purchase applications."
Despite the fact that mortgage rates have continued to spike at breakneck speed this summer, sources note that there have been stronger home sales this year than last, when mortgage rates were between 50 basis points and 75 basis points lower.
Additionally, house prices have gone up considerably along with mortgage rates, which still makes housing a good investment.
"An 8% interest rate turns out to be a little over 5% after taxes, depending on your state and your bracket," said Freddie Mac's Van Order. "Appreciation and tax deduction are basically paying the interest. So that part of the market is still pretty strong. But if rates go up a bit more the people who refinanced last year at 6.5% and 7% would consider trading up to a higher mortgage rate to be expensive, so this will help slow sales down."
For the current year, Freddie Mac's Cuts expects house price appreciation to be in the 4% to 4.5% range, which represents a slight slowdown from 1998, when appreciation was above 5% for each of the four quarters - an above-average year by all standards.
"There is a lot of demand for new housing right now, which is a little bit inconsistent with the slowdown in the first quarter ," Cuts said. "When we revise our numbers for the second quarter, my guess is that the revision is going to be upward."
Further, a change to the U.S. Tax Code in 1997 made primary residences virtually capital gains tax-free, so consumers have less disincentive to leave their big suburban houses once their children are grown.
"They now can [leave their homes] free of capital gains taxes in almost all circumstances," said Art Frank, head of mortgage research at Nomura Securities. "Demographics remain pretty favorable, too.
"With the late baby boomers in their mid-30s - the classic move-up age - moving to suburban homes, and the oldest boomers in their 50s moving out of their homes as their kids move away...we see housing turnover continuing pretty strong, even with an 8% 30-year mortgage rate," he said.