Mortgage Rates Take a Breather

You would think mortgage rates would need a breather after experiencing their biggest jump in 26 years. In little more than a month, rates on most lending products have risen at least a full percentage point.

This past week, it was all quiet on the mortgage front. Rates were mostly staid, as concerns over the Federal Reserve “tapering” its purchases of mortgage backed securities (MBS) waned. As we’ve noted frequently in the past, the Fed's demand for these securities keeps yields low, which, in turn, keeps mortgage rates low.

We've also reported over the past few weeks how rising rates have taken the steam out of refinances. Steam continues to escape: Refinances dropped another 16% last week and are at their lowest level since July 2011. The refinance percentage of market activity has dropped to 64%, which is the lowest percentage since May 2011.

Purchase activity remains relatively robust in comparison, falling 3% for the reported week. But when the longer term is considered, we find purchase activity is up 12% year over year. Despite the spike in mortgage rates, home affordability remains high. The good news is that higher financing costs haven't materially dampened enthusiasm to buy and finance a home.

The question is how long will affordability remain high?

Prices have moved considerably higher, to be sure. CoreLogic's latest home price index shows home prices nationally posted a 15 th consecutive monthly increase in May. The latest increase pushes the year-over-year increase to 12.2%, the largest annual increase in over seven years.

What's more, it appears we can look forward to additional price gains. Clear Capital forecasts the housing market could outperform historical average price gains by 4% to 5% for the remainder of 2013.

Prices are obviously an important variable in affordability. Rising prices will make homes less affordable. Indeed, price gains have lowered affordability in many local markets ( San Francisco and New York City come immediately to mind). On the other side of the coin, price gains have pulled many owners with negative equity into positive territory.

Rising prices are also helping to alleviate the supply shortage. Home inventory is up 16.7% year to date, and will likely continue to rise with rising home prices. A basic economic law states supply rises and falls with prices; rising prices induce more supply to come to market. That's exactly what we are seeing today.

But more supply will eventually slow price growth. That's not a bad thing. Today's double-digit price gains are unsustainable, because they far exceed economic growth. Yes, prices are starting from a deep hole in many markets, but eventually price growth must moderate, lest we find ourselves in another housing bubble.

A sustainable price-growth rate is one that matches inflation and economic growth. A rate above that is sustainable for only a limited time, usually no more than two or three years.

For now, keep in mind that higher home prices and higher lending rates will eventually impact affordability. We might sound like a broken record on this point, but it's worth repeating: waiting is the risk in this market.

 Courtesy of Jessica Regan.

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