Interest-Rate Hike Could Keep Home Buyers Away

Jim Morgo tries to devise ways to shoehorn low-income families into their own homes on Long Island. Even a slight rise in interest rates can make the difference between home ownership and rejection by the banks. So Mr. Morgo has a message for Federal Reserve chairman Alan Greenspan: "Keep rates low, we don't need to worry about inflation."

Within the interest-rate sensitive housing industry, Morgo, president of the Hauppauge-based Long Island Housing Partnership, is not alone. "Even if rates only rise 1/4 of a percent, the perception is that interest rates are on the rise and that's all people will read," says Ken Klein, president of Kleinco Construction Company in Tulsa, Okla. "And people will say, 'Honey, we're not going to buy a house.' "

But economists are sanguine that Mr. Greenspan and the Fed won't move rates higher when the Fed's Open Market Committee begins a two-day meeting today. "We think the Fed will wait for more data," says David Lereah, chief economist at the Mortgage Bankers Association in Washington. Coming up on Friday, for example, are the June unemployment numbers. Most economists say they believe this report will determine whether the Fed decides to raise interest rates - perhaps as early as next week.

Some economists, however, fretted that the Fed would be displeased with the news yesterday that consumer spending increased by 0.8 percent, the best advance since February. In a separate report, the National Association of Purchasing Management reported that its latest survey showed the economy grew strongly in June.

Even without the Fed's action, the housing industry is already starting to slow down as a result of higher long-term interest rates. On July 1, the Commerce Department reported May construction spending declined by 0.9 percent after a 2 percent gain in April. Spending on single-family housing slipped 0.6 percent. Builders are afraid that a move by the Fed will be like yanking the nails out of the two-by-fours.

Lereah figures that the housing industry loses 100,000 buyers when interest rates rise by 1/2 of a percent. Over the past two months, mortgage rates have climbed by about 3/4 of a percent to about 8-1/4 percent for a fixed rate 30-year mortgage. This means about 150,000 buyers have been shut out of the housing market in the past two months. On a $100,000 mortgage, the monthly payments have moved from $733 a month to $770 a month.

The biggest impact of the rate rise is on low-income families buying their first home. Even a small rate rise changes the debt-to-income ratios that bankers look at to determine if a family can handle the monthly payments. "Even a 1/4 of a percent sends some of them over the limit," says Morgo, whose typical client buys homes in the $42,000 to $98,000 range.

There is a more subtle effect on second-time home buyers who normally buy homes in the $180,000 range. A rate rise "will knock $10,000 off what they can afford ... everyone is driven by that monthly payment," says Bill Fannin Jr. of William Fannin Builders Inc. in Columbus, Ohio. He says buyers of more expensive houses start to eliminate the extras in a house, such as new drapes or an extra bathroom.

Because of rising rates earlier this year, the industry is already downsizing its expectations for the full year. "I am looking for the housing markets to contract later this year," Lereah says. There are already some signs that this is happening. Last week the Bureau of Labor Statistics reported housing starts fell 4.7 percent in May to a 1.43 million unit rate. This is the lowest level since December last year.

"We expect further erosion in housing activity during the second half of this year," predicts Bruce Steinberg, an economist with Merrill Lynch & Co. in New York.

A decline in the housing markets will ripple through the nation's economic fabric. New residential home building represents about 4 to 5 percent of the nation's gross domestic product. All construction, including commercial building, represents 12 percent of the GDP. Housing generally leads the economy out of economic downturns, says Gopal Ahluwalia, director of research at the National Association of Home Builders in Washington.

Although interest rates can cool the housing market, some local markets can continue to grow because of strong economic growth. Mr. Ahluwalia says the strongest housing markets are now in Atlanta, Denver, and Phoenix. California has recovered from its low point but is still far from its peak production. Almost all the "hot" areas are enjoying healthy job and population growth.