Minor price declines are certainly possible. The states most
at risk for seeing price declines (according to the Arch MI Risk
Index) are similar to those that have the weakest housing
markets this year, including Alaska, Connecticut, Mississippi,
Louisiana and West Virginia.
Interest rates are set for a further gradual rise this year —
but keep in mind that rate spikes in today’s global economy
are somewhat self-correcting because they cool economic
growth, creating pressure for rate moderation or decreases. The average 30-year fixed mortgage rate may average
between 5 and 5. 25 percent this coming year.
Rising rates have historically caused a mild slowdown in
transactions, slowed home-price growth and a large reduction in refinances. One estimate of the size of the typical
impact of higher rates comes from J.P. Morgan researchers
who found that each rate increase of 0.25 percent trims
homes sales by roughly 2 percent.
With supply still tight, history suggests the odds of seeing
widespread material home-price declines are slim. Looking
back at past bump-ups in mortgage rates finds that higher
rates didn’t result in falling home prices, with one glaring
exception — the housing bust of 10 years ago.
It isn’t that this time is different. It’s that last time was different.
A decade ago, the U.S. was oversupplied with homes and was
awash in crazy loan products that no longer exist, such as no-doc
loans. History suggests that while higher mortgage rates cause
some buyers to temporarily hold off, employment is a more
important determinant of housing demand in the long run.
Painful, but overdue
Mortgage rates are likely headed higher over the next year.
The Federal Reserve is gradually reducing, or tapering, its
purchases of agency mortgage-backed securities to replace
run-offs. This alone may increase mortgage rates by roughly
0.25 percent over the next few years.
The federal government’s budget deficit is large and rising
rapidly. In order to find buyers for all those additional bonds,
higher interest rates may be needed. The Federal Open
Market Committee has raised the funds target rate by
0.75 percent so far this year and their projections imply
several more to come.
While there are many reasons to expect mortgage rates
to increase modestly, the direction and pace of interest rate
increases is uncertain since it depends on future inflation,
policy changes, economic and financial market conditions
and events overseas. Painful higher rates were overdue, but if
rates had risen to more normal levels sooner, home prices in
hot markets would not have gone up as much.
Mortgage originators can see that a long-anticipated slowdown has finally arrived. Both home sales and price growth
are slowing quickly, particularly in the West. The slowdown
is likely to worsen, given mortgage rates could rise another
quarter to half a percentage point over the next few years.
This will cause home-price growth to continue to slow, but
a housing bust doesn’t seem imminent, thanks to the strongest job market in 20 years, a shortage of housing and strong
(but temporary) federal stimulus — at least for the next six
to 12 months. In addition, mortgage rates are up but are still
relatively low. Mortgages rates have been higher than today’s
rates more than 80 percent of the time since 1970.
Even with higher mortgage rates and some markets now
overvalued, solid economic growth, a healthy labor market
and a shortage of entry-level homes should prevent material
declines in home prices. More specifically, national home prices could grow in the 2 to 4 percent a year range as long as the
U.S. continues to have an overall healthy job market.
Price growth has been too strong for several years, fueled
in part by abnormally low interest rates. A mild deceleration
in home sales and Home Price Index growth is actually
healthy, because it will calm excessive price growth — which
has pushed many markets, particularly in the West, into
overvalued territory. n
Reasons to be optimistic about the housing market
n■ Total employment is at a record high.
n■ Federal spending remains up.
n■ The stimulus tax cut is adding dollars to economy.
n■ The housing shortage continues.
n■ Mortgage rates are still historically low.
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