Rising mortgage rates add to housing woes

Higher mortgage rates since March are tied in part to investors' inflation worries.

Rising mortgage rates, reflecting higher inflation, are starting to compound the US housing market's woes.

Since March, mortgage rates have climbed as much as a full percentage point. For someone borrowing, say, $400,000, that could tack an extra $320 onto the monthly payment.

The implications of rising mortgage rates are not good, say economists and mortgage industry specialists. With the housing market still very weak, higher mortgage rates will act like a brake on any recovery in the sector. A hobbled housing market, moreover, means the economy as a whole will remain weak.

"The housing market needs to recover for the economy as a whole to fully recover," says Lawrence Yun, an economist at the National Association of Realtors in Washington. "Without housing recovering, the economy will remain sluggish."

Mortgage rates now range from 6.4 percent to 7.0 percent for a 30-year fixed-rate mortgage, depending on the issuer. That's an increase of anywhere from a half a percentage point to a full percentage point higher than the rates earlier this spring.

Higher interest rates on home loans mean home buyers must either put up a larger down payment or find a different house they can afford. For individuals seeking to refinance their homes, higher interest rates may ultimately force more foreclosures for those who are already financially stretched.

Home lending rates started ratcheting up even while the Federal Reserve has been lowering short-term interest rates. Since March, the Fed has lowered rates one full percentage point. But the Fed has less influence on long-term interest rates, such as the 10-year Treasury rate. Long-term rates have jumped as investors have started worrying about inflation. Through May, the Consumer Price Index is running at a 4 percent annual rate.

"When you cut through it, bond traders only care about inflation: What is the value of their dollar when they get it back?" says Bob Walters, chief economist at Quicken Loans in Livonia, Mich.

Another reason mortgage rates are rising is because banks don't want to lend money at the same profit margins as they did during the past few years, when they aggressively made loans for little profit.

"The banks' perception of risk is changing," says Alan Rosenbaum, CEO of Guardhill Financial, a mortgage brokerage based in New York. "Some of them don't want to make loans at all."

For example, through a mortgage broker such as Mr. Rosenbaum, JP Morgan Chase is offering a jumbo (over $729,000) five-year adjustable-rate mortgage for 8.75 percent. "That is basically them saying, 'We are not lending,' " says Rosenbaum.

Banks have also been tightening their loan criteria. Borrowers today need to have higher credit scores and larger down payments than they did as recently as last year. "All the banks want the best borrowers," says Bob Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

Mr. Moulton recounts the tale of a client who wanted to refinance a condo in New York City. But the individual worked for Bear Stearns, the investment bank that was recently absorbed by Chase. "The lender wanted a letter guaranteeing his employment, which could not be obtained," he says. "And the loan was not approved."

Lenders also are leery about lending money to individuals who are right on the edge of being able to afford their monthly payment. Banks assessing a loan application typically divide the applicant's income into thirds, explains Rob Harrington of OptHome, an online consumer resource on loans. One-third goes toward taxes; a second third is for housing, such as the mortgage payment; and the last third is for household expenses.

"But if household expenses are rising, such as higher prices for gasoline, where is the money coming from?" he says. "People coming after mortgages today don't have as much disposable income."

The rise in mortgage rates also affects a key factor in assessing a bank loan: the applicant's debt-to-income ratio. Pulling out a loan application for a $295,000 refinancing, Matthew Graham, a mortgage broker for Excalibur Inc. in Portland, Ore., says a mortgage rate of 6 percent would result in a debt-to-income ratio of 43 percent for that client. But with mortgage rates now closer to 7 percent, the ratio for his client shoots up to 46 percent because the debt portion of the loan has increased.

"Now, instead of financing $295,000, the client can only do $265,000 – a $30,000 decrease according to the underwriting guidelines," says Mr. Graham, who is also a columnist for Mortgagenewsdaily.com. "In a worst-case scenario, he can't refinance to pay off the mortgage and has to go into foreclosure."

The rate increases come as delinquencies and foreclosures continue to rise.

"We have not seen any improvement," says Jon Thompson, a vice president of St. Paul-based Advantus Capital Management, which purchases loans.

Mr. Thompson says some analysts worry that the housing and mortgage market is locked in a vicious spiral. It starts with falling home prices, which are reflected in lower-valued mortgages. Investors take write-downs of their mortgage portfolios and need to raise new capital. Lenders tighten lending standards, which cuts the number of potential buyers. Fewer buyers means home prices must fall further, restarting the cycle.

Falling home prices, however, are starting to make housing more affordable.

"Affordability has risen sharply," says Bob Brusca of Fact and Opinion Economics in New York. "In February homes were the most affordable they have been since March of 2003, but with this rise in mortgage rates affordability is starting to backtrack."