Warning! Mortgage Rates Are Definitely Headed Higher

I have no idea what mortgage rates are going to do tomorrow, next week, or next month. But because of the significance of mortgage rates to the housing market, and therefore the overall economy, it's nevertheless worthwhile getting the lay of the land. And there are two important things to keep in mind with regard to mortgage rates, the first of which is that they've shot up considerably over the past few months.

The catalyst, if you recall, was the Federal Reserve's announcement at the end of May that it could soon begin to taper its support for the economy.

The connection between the central bank and mortgage rates runs through the bond market. That is, the Fed will reduce its support for the economy by buying fewer mortgage-backed securities (which are bond-type instruments backed by mortgages). As it does so, the price for MBSes will decline, leading to a concomitant increase in their interest rates (bond prices and interest rates are inversely related).

This will then filter down to the collateral itself -- namely, mortgages.

The second point is that I don't think it's unreasonable to say that the Fed will indeed, at some point, embark on this course. But here's the catch: We have no idea when it will do so.

Most commentators who discuss this topic seem convinced it will happen at the Fed's upcoming meeting, scheduled to take place in the second week of September. But this is pure speculation. The same thing has been reiterated time and again over the past couple of months, yet the central bank has stayed put.

What you can bet on
The most that can be said is that once the Fed does pull the trigger, it will be only because the economy has shown robust signs of recovery. More specifically, it won't do so until unemployment is substantially lower.

With that in mind, one can't help concluding that higher mortgage rates would be almost categorically positive. And that goes beyond what it would mean for the economy in a general sense.

Take banks as an example. Lenders such as Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) have been yearning for higher long-term interest rates to juice their bottom lines. All of these banks have seen their net interest margins contract by more than 50 basis points over the past year, with JPMorgan hit the worst. Consequently, a reversal of this trend would be a welcome relief to both executives and investors alike. 

And the same can be said of homebuilders such as Hovnanian and Toll Brothers. While higher rates may crimp their customers on the margin, the broader population of people will be in a better position to purchase new homes in the face of lower unemployment. It's worth noting, moreover, that a pickup at companies like these would provide an additional stimulant to the economy, as it's estimated that between two and three jobs are created for every home that's built.

The bottom line is that, yes, mortgage rates will probably go higher. The catch is that nobody knows when. It could be days, weeks, months, years, or even decades before that happens. But when it does, it's important to keep in mind that the move is a positive sign and not a negative one.

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Read/Post Comments (7) | Recommend This Article (5)

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  • Report this Comment On August 18, 2013, at 2:59 PM, tradingfool13 wrote:

    The markets have reached these levels mainly because of the printing press in Wash . When that ends the market will lose at least 20% of present levels and maybe more . The nations debt will be dealt with by the US getting it's house in order or the markets will press the issue .

  • Report this Comment On August 18, 2013, at 9:57 PM, gl2238 wrote:

    This editor does not know what he is talking about. Yes unemployment is less but the new employment is part time and these folks cannot afford homes. In fact, they are the new middle class applying for food stamps. Furthermore, those that last year could maybe still afford a home who were full time are now part time tnx to ObamaCare and also cannot afford a home. U6 is over 14% and is probably closer to 16%. U3 is an absolutely useless number and this editor should know this before writing this report.

  • Report this Comment On August 19, 2013, at 12:20 PM, TMFGortok wrote:

    If Mortgage interest rates increase, wouldn't that cause housing prices (and subsequently, the value of other houses) to fall, causing people who have homes with little equity to go underwater on their mortgages?

  • Report this Comment On August 19, 2013, at 12:27 PM, TMFHousel wrote:

    ^ All else equal, yes. But all else is never equal. Rising rates are usually associated with stronger growth with itself can boost prices. The historical correlation between interest rates and home prices is very low. Remember that during the housing bubble last decade short-term interest rates went from 1% to 6.25%.

  • Report this Comment On August 19, 2013, at 12:30 PM, TMFHousel wrote:

    which* itself.

    Robert Shiller has the best historical data on real home prices, interest rates and building costs.

    http://www.econ.yale.edu/~shiller/data/Fig2-1.xls

  • Report this Comment On August 19, 2013, at 12:34 PM, broknrekord3 wrote:

    @TMFGortok That would logically make sense, but since only 3% or so +/- (I can't find any statistics on it, but I'm basing that on the amount of homes in my city for sale versus how many exist) are actively on the market, I don't think it's quite a fully equal trade-off between home value and purchasing power. Because of such strong demand and limited choice, housing will continue to stay strong and lose little -if any- value from rising interest rates (at least when going up a couple percentage points). I think this may change if we see rates climb above 8%, where that little extra interest starts to really add up.

    I also think that the psychological impact of mortgage rates going higher will push people to jump on homes, afraid they'll miss out on the lower interest rates, and that the market may go flat once rates break 6.5% (the rate most first-time home buyers are paying for student loan debts). At that point the leveraging of debt for those first-time home buyers won't make as much sense, and prices may stagnate. This is all assuming the rest of the market remains as is without any new spikes or fallouts.

    Then again, I don't really have any evidence to fall back on except personal experience working in real estate law and being a recent first-time home buyer.

  • Report this Comment On September 17, 2013, at 3:36 PM, alexanderestrin wrote:

    Great article. To see charts and a discussion on how Treasuries affect mortgage rates, follow this link: http://www.alexanderestrin.com/dive-into-real-estate/mortgag...

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