Interest Rates Impact of Affordability

Interest Rates Impact of Affordability

With the biggest rise of interest rates in 25 years the refinancing activities has come to a screeching halt with refinancing applications dropping to 2-year low. Applications for purchase loans have also declined by 4%.  This has given some economist concern that housing market recovery will be in serious jeopardy.

According to the Mortgage Bankers Association (MBA), average rate on 30-year mortgage loan, which was as low as 3.59% at the beginning of May, had moved up to 4.58% by June 2014. This has left some anxious home buyers worried about their ability to own their dream home!

Federal Reserves Role: 

The Federal Reserve Bank intervened in the mortgage market after the housing crash of 2007.  The aim of Federal Reserve Bank was to lower interest rate in order to stimulate the ailing economy.   Fed embarked on quantitative easing (QE) policy – purchase of mortgage-backed securities to lower down the mortgage rate.  In fact, Federal Reserve has purchased $40 billion worth of mortgage-backed securities and $45 billion in Treasury bills in an attempt to maintain the low interest rates on mortgages.  The low rates added to home affordability of the borrowers. This enabled home buyers access to cheap financing which fueled residential housing boom and recovery.

Recently  Federal Reserve Bank announced that it will gradually slow down its spending on QE easing by the end of 2013.  FED also signaled that they will end the QE easing all-together by 2014. The announcement of Fed has been prompted by better economic fundamentals. This has been echoed in the speech of Ben Bernanke, the Chairman of the Federal Reserve. He commented, “The housing sector, which has been a drag on growth since the crisis, is now, obviously, a support to growth. It’s not only creating construction jobs, but as house prices rise, increased household wealth supports consumption spending, consumer sentiment.”

However, stronger economic data and expectations that the Fed would slow down the purchases of mortgage-backed securities and Treasury bonds, have caused the bond investors to start sell out of their Treasury positions. This has driven the bond yields. With rise in the yields, rate on the mortgage has also moved northwards.

Dwindling fortunes of the home buyers

The Fed’s plans have impacted the mortgage market in a big way. It has prompted some home buyers to rush into home buying activities before the rates move further up. Economists however expect that this is short term phenomenon. The bigger question remain on what will happen to the property market after this rush of last-minute buying wanes away and the crude reality of appreciably high rates actually set in.

Many experts believe that direct effects of high interest rates would come in the form of slowing down of home sales and construction activities. As a rule of thumb, it is said that 1% increase in mortgage rates lowers the affordability down by 10%.  So the present increase in mortgage rates has just made homes about 10% more costly for the home buyers.  This would force the consumers tighten their purse strings.

Still hope persists

Many experts are still hopeful that the property market which just started to tread into recovery after enduring a 5-year long recession, will weather this storm of ‘high mortgage rate’.   Home prices are still very low and mortgage rates are still within the affordable limits of the home buyers.  Many economists believe that by historical standards, housing is still within the affordable limit even at a rate of 4.5% or 5%.  Analysts at Bank of America opine that mortgage rate has to climb to around 6% so as to make housing affordable to the home buyers.


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