FreddieMac reported this week that the average rate on a 30 year fixed rate mortgage climbed sharply to 6.74% (with an average of 0.4% points), up from 6.53% last week. The rate on the 30 year fixed is the highest since July 2006. Mortgage rates have increased now five weeks in a row and are closing in on the psychological 7% level.
The direct impact of higher mortgage rates is on affordability. Borrowing $250,000 at 6% will result in a monthly payment of $1,500 (on a 30 year fixed rate mortgage). At 7%, the same $250,000 will cost $1,662.50 per month, an increase of 10.8%. For a borrower at their mortgage qualifying ceiling, it means they can only afford a house that is about 10% less expensive. A few years ago, a borrower might decide to shift to an Adjustable Rate Mortgage (ARM), with lower initial monthly payments, to afford a more expensive house. But ARMs have gotten a black eye in the last year, as borrowers find that those loans do adjust, and they face sharply higher monthly payments.
In the second home market, which is much of what I handle, borrowers are usually not near their mortgage qualifying ceiling and can often afford the higher payments resulting from higher mortgage rates. But in the second home market – which is discretionary, after all – there may be an indirect, more psychological impact. In primary home markets, higher interest rates may have a exert a moderating to downward pressure on prices, even in higher demand areas like NYC which have weathered the downturn quite well. There will be a segment of buyers that will have to downshift their price point to qualify for a house. A buyer that was looking in the $400,000 range when rates were around 6% may now be looking in the $350,000 to $375,000 range. There’s also the looming shadow, particularly at the "affordable" end of the market, of increasing foreclosures resulting from the resetting of adjustable rate mortgages to higher mortgage rates, resulting in a sharp rise in inventory that lenders are looking to unload.
Overall, what we’re probably looking at is uncertainty over the next few months. Will interest rates go up or go down? Will foreclosures, particularly in the subprime market, increase? Will the government step in to help owners keep from losing homes to foreclosure? Uncertainty may just cause many buyers to decide to wait, to see how things settle out.
There is some good news in all of this. In news reports this week, many experts attribute the rise in interest rates to string consumer and business spending along with wage increases — which are indicators of economic strength, and reduce the likelihood that the Fed will pull back interest rates anytime soon.