Are Mortgage Rates Too Low? Making the Case for Higher Rates

By Matt Egan Features FOXBusiness


By providing the markets with a giant easy-money punchbowl, the Federal Reserve has sought to give Americans an extra incentive to buy a home: off-the-charts low mortgage rates.

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But what if the Fed’s pledge to keep interest rates ridiculously low through 2014 is actually having the opposite impact and by keeping potential homebuyers on the sidelines?

That thinking has led some to wonder whether a modest uptick in mortgage rates from their basement bottom levels would actually help light a fire under the housing market, which is just beginning to show some signs of life.

“Potential buyers have been provided an environment where they can afford to be complacent,” said David Joy, chief market strategist at Ameriprise Financial (AMP). “If we saw some evidence that mortgage rates are rising it would maybe awaken some potential buyers from their complacency and force them to pull the trigger.”

According to Freddie Mac, the average rate on a 30-year fixed-rate mortgage rose this week to 3.95%, ending a three-week streak of being stuck at an all-time record low of 3.87%. Rates have been under 4% for the past 12 weeks, less than half their February 2000 levels of 8.33%. 

“We’ve been arguing for some time that these ultra low rates are doing more harm than good,” said Walter Zimmerman, senior vice president at United-ICAP. “If rates are going to be kept at rock-bottom levels for the next few years, then what the heck is the incentive to go out and buy? There is none.”

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Chilling Effect?

To be sure, it’s not clear to many that the still-weak housing market is healthy enough for higher mortgage rates just yet. Sure, the U.S. economy appears to be gaining some steam, but the recovery remains fragile and is subject to potential shocks from turmoil in the Middle East and events in the eurozone.

“People aren’t going to rush into a home purchase based solely on movement in mortgage rates any more than people rush to get married because of a sale at a bridal shop,” said Greg McBride, senior financial analyst at (RATE). “Nobody is holding out thinking mortgage rates are still too darn high.”

Instead, McBride said potential homebuyers are sitting on the fence because they aren’t comfortable with their own financial situation and/or aren’t sold that home prices won’t continue to drop.

While the National Association of Realtors revealed this week existing home sales rose by 4.3% in January and inventories fell to April 2006 levels, the industry group also said the median price of a home sold slipped 2.6% year-over-year to territory unseen since 2001.

Creating an Incentive

Still, it remains hard to predict exactly how the housing market would respond to signs mortgage rates have finally hit bottom.

Zimmerman said the argument that the market isn’t ready for higher mortgage rates is hard to prove.

Those calling for a continuation of ultra-low rates “didn’t predict the housing bubble and were completely blindsided by it, but now suddenly they can see the future,” said Zimmerman.

Joy concedes that markedly higher rates over the long run will temper demand for mortgages and ultimately hurt sales.

However, he doesn’t believe a near-term moderate rise doing damage. “I’m not sure a rise in rates would have too much of a chilling effect because they would have to rise meaningful in order to be anywhere but at a historical row,” said Joy.

To that point, even if mortgage rates leaped from their current levels to 5%, that would still be their lowest levels on record besides the post-housing collapse.

“If there’s no threat that rates might go up, they’ll say, ‘Okay I’ll take my time and wait another couple of months,’” said Joy.

When Will Rates Rise?

Housing market watchers will be watching to see how rates respond if the Fed allows its Operation Twist program to sunshine as scheduled in June. The program, which involves selling $400 billion of short-term Treasuries in exchange for longer-term bonds, aimed to bring down mortgage rates.           

The Fed has also pledged to keep rates extraordinarily low for the next two years to allow the economy to get back on its feet and in an effort to spur confidence in the markets.

“This transparency may actually to some extent be resulting in the opposite reaction, which is complacency rather than confidence,” said Joy.

But if economic growth over the next quarter or two continues to pick up steam, the Fed may be forced to go back off on its easy-money promise and eventually nudge rates higher.

There are a few tepid signs mortgage rates will soon or may have already hit a bottom. Joy pointed to a slight rise in the availability of financing in terms of lending standards as well as rise in credit demand.

While the Mortgage Bankers Association’s reading on applications slipped in the week ended February 10, it averaged 806 in the first two weeks of February, up from 752 in January and 657 in December.

Anecdotally, Joy said conversations with Boston-area bankers and appraisers offered signs of hope. “All of a sudden their activity has really popped,” he said, although he conceded the unseasonably warm weather may be the cause.