There are a large number of public and private services that measure the change in home prices. The algorithms behind these services, while complex, are primarily based on recent sale prices for comparative homes and adjusted for factors like location, property characteristics and the particulars of the house. While these pricing services are considered to be well represented measures of house prices, there is another important factor that is frequently overlooked despite the large role in plays in house prices.
In August 2016, the 30-year fixed mortgage rate as reported by the Federal Reserve hit an all-time low of 3.44%. Since then it has risen to its current level of 4.50%. While a 1% increase may appear small, especially at this low level of rates, the rise has begun to adversely affect housing and mortgage activity. After rising 33% and 22% in 2015 and 2016 respectively, total mortgage originations were down -16% in 2017. Further increases in rates will likely begin to weigh on house prices and the broader economy. This article will help quantify the benefit that lower rates played in making houses more affordable over the past few decades. By doing this, we can appreciate how further increases in mortgage rates might adversely affect house prices.
In 1981 mortgage rates peaked at 18.50%. Since that time they have declined steadily and now stands at a relatively paltry 4.50%. Over this 37-year period, individuals’ payments on mortgage loans also declined allowing buyers to get more for their money. Continually declining rates also allowed them to further reduce their payments through refinancing. Consider that in 1990 a $500,000 house, bought with a 10%, 30-year fixed rate mortgage, which was the going rate, would have required a monthly principal and interest payment of $4,388. Today a loan for the same amount at the 4.50% current rate is almost half the payment at $2,533.
The sensitivity of mortgage payments to changes in mortgage rates is about 9%, meaning that each 1% increase or decrease in the mortgage rate results in a payment increase or decrease of 9%. From a home buyer’s perspective, this means that each 1% change in rates makes the house more or less affordable by about 9%.
Given this understanding of the math and the prior history of rate declines, we can calculate how lower rates helped make housing more affordable. To do this, we start in the year 1990 with a $500,000 home price and adjust it annually based on changes in the popular Case-Shiller House Price Index. This calculation approximates the 28-year price appreciation of the house. Second, we further adjust it to the change in interest rates. To accomplish this, we calculated how much more or less home one could buy based on the change in interest rates. The difference between the two, as shown below, provides a value on how much lower interest rates benefited home buyers and sellers.
Data Courtesy: S&P Core Logic Case-Shiller House Price Index
The graph shows that lower payments resulting from the decline in mortgage rates benefited buyers by approximately $325,000. Said differently, a homeowner can afford $325,000 more than would have otherwise been possible due to declining rates.
As stated, mortgage rates have been steadily declining for the past 37 years. There are some interest rate forecasters that believe the recent uptick in rates may be the first wave of a longer-term change in trend. If this is, in fact, the case, quantifying how higher mortgage rates affect payments, supply, demand, and therefore the prices of houses is an important consideration for the direction of the broad economy.
The graph below shows the mortgage payment required for a $500,000 house based on a range of mortgage rates. The background shows the decline in mortgage rates (10.00% to 4.50%) from 1990 to today.
To put this into a different perspective, the following graph shows how much a buyer can afford to pay for a house assuming a fixed payment ($2,333) and varying mortgage rates. The payment is based on the current mortgage rate.
As the graphs portray, home buyers will be forced to make higher mortgage payments or seek lower-priced houses if rates keep rising.
The Fed has raised interest rates six times since the end of 2015. Their forward guidance from recent Federal Open Market Committee (FOMC) meeting statements and minutes tells of their plans on continuing to do so throughout this year and next. Additionally, the Fed owns over one-quarter of all residential mortgage-backed securities (MBS) through QE purchases. Their stated plan is to reduce their ownership of those securities over the next several quarters. If the Fed continues on their expected path with regard to rates and balance sheet, it creates a significant market adjustment in terms of supply and demand dynamics and further implies that mortgage rates should rise.
The consequences of higher mortgage rates will not only affect buyers and sellers of housing but also make borrowing on the equity in homes more expensive. From a macro perspective, consider that housing contributes 15-18% to GDP, according to the National Association of Home Builders (NAHB). While we do not expect higher rates to devastate the housing market, we do think a period of price declines and economic weakness could accompany higher rates.
This analysis is clinical using simple math to illustrate the relationship, cause, and effects, between changes in interest rates and home prices. However, the housing market is anything but a simple asset class. It is among the most complex of systems within the broad economy. Rising rates not only impact affordability but also the general level of activity which feeds back into the economy. In addition to the effect that rates may have, also consider that the demographics for housing are challenged as retiring, empty-nest baby boomers seek to downsize. To whom will they sell and at what price?
If interest rates do indeed continue to rise, there is a lot more risk embedded in the housing market than currently seems apparent as these and other dynamics converge. The services providing pricing insight into the value of the housing market may do a fine job of assessing current value, but they lack the sophistication required to see around the next economic corner.
Yesterday when looking at the latest MBA Mortgage Application data, we found that, as mortgage rates jumped to the highest level since 2011, mortgage refi applications, not unexpectedly tumbled to the lowest level since the financial crisis, choking off a key revenue item for banks, and resulting in even more pain for the likes of Wells Fargo.
Today, according to the latest Freddie Mac mortgage rates report, after plateauing in recent weeks, mortgage rates reversed course and reached a new high last seen eight years ago as the 30-year fixed mortgage rate edged up to 4.61% matching the highest level since May 19, 2011.
But while the highest mortgage rates in 8 years are predictably crushing mortgage refinance activity, they appears to be having the opposite effect on home purchases, where there is a sheer scramble to buy, and sell, houses. As Bloomberg notes, citing brokerage Redfin, the average home across the US that sold last month went into contract after a median of 36 only days on the market – a record speed in data going back to 2010.
To Sam Khater, chief economist of Freddie Mac, this was a sign of an economy firing on all cylinders: “This is what happens when the economy is strong,” Khater told Bloomberg in a phone interview. “All the higher-rate environment does is it either causes them to try and rush or look at different properties that are more affordable.”
Of course, one can simply counter that what rising rates rally do is make housing – for those who need a mortgage – increasingly more unaffordable, as a result of the higher monthly mortgage payments. Case in point: with this week’s jump, the monthly payment on a $300,000, 30-year loan has climbed to $1,540, up over $100 from $1,424 in the beginning of the year, when the average rate was 3.95%.
As such, surging rates merely pulls home demand from the future, as potential home buyers hope to lock in “lower” rates today instead of risking tomorrow’s rates. It also means that after today’s surge in activity, a vacuum in transactions will follow, especially if rates stabilize or happen to drop. Think “cash for clunkers”, only in this case it’s houses.
Meanwhile, the short supply of home listings for sale and increased competition is only making their purchases harder to afford: according to Redfin, this spike in demand and subdued supply means that home prices soared 7.6% in April from a year earlier to a median of $302,200, and sellers got a record 98.8% of what they asked on average.
Call it the sellers market.
Furthermore, bidding wars are increasingly breaking out: Minneapolis realtor Mary Sommerfeld said a family she works with offered $33,000 more than the $430,000 list price for a home in St. Paul. The listing agent gave her the bad news: There were nine offers and the family’s was second from the bottom.
For Sommerfeld’s clients, the lack of inventory is a bigger problem than rising mortgage rates. If anything, they want to close quickly before they get priced out of the market — and have to pay more interest.
“I don’t think it’s hurting the buyer demand at all,” she said. “My buyers say they better get busy and buy before the interest rates go up any further.”
Then again, in the grand scheme of things, 4.61% is still low. Kristin Wilson, a loan officer with Envoy Mortgage in Edina, Minnesota, tells customers to keep things in perspective. When she bought a house in the early 1980s, the interest on her adjustable-rate mortgage was 12 percent, she said.
“One woman actually used the phrase: ‘Rates shot up,’” Wilson said. “We’ve been spoiled after a number of years with rates hovering around 4 percent or lower.”
Of course, if the average mortgage rate in the America is ever 12% again, look for a real life recreation of Mad Max the movie in a neighborhood near you…
On the heels of the 10Y treasury yield breaking out of its recent range to its highest since July 2011, this morning’s mortgage applications data shows directly how Bill Gross may be right that the economy may not be able to handle The Fed’s ongoing actions.
As Wolf Richter notes, the 10-year yield functions as benchmark for the mortgage market, and when it moves, mortgage rates move. And today’s surge of the 10-year yield meaningfully past 3% had consequences in the mortgage markets, as Mortgage News Daily explained:
Mortgage rates spiked in a big way today, bringing some lenders to the highest levels in nearly 7 years (you’d need to go back to July 2011 to see worse). That heavy-hitting headline is largely due to the fact that rates were already fairly close to 7-year highs, although today did cover quite a bit more distance than other recent “bad days.”
The “most prevalent rates” for 30-year fixed rate mortgages today were between 4.75% and 4.875%, according to Mortgage News Daily.
And that is crushing demand for refinancing applications…
Despite easing standards – a net 9.7% of banks reported loosening lending standards for QM-Jumbo mortgages, respectively, compared to a net 1.6% in January, respectively.
According to Wolf Richter over at Wolf Street, the good times in real estate are ending…
The big difference between 2010 and now, and between 2008 and now, is that home prices have skyrocketed since then in many markets – by over 50% in some markets, such as Denver, Dallas, or the five-county San Francisco Bay Area, for example, according to the Case-Shiller Home Price Index. In other markets, increases have been in the 25% to 40% range. This worked because mortgage rates zigzagged lower over those years, thus keeping mortgage payments on these higher priced homes within reach for enough people. But that ride is ending.
And as Peter Reagan writes at Birch Group, granted, even if rates go up over 6%, it won’t be close to rates in the 1980’s (when some mortgage rates soared over 12%). But this time, rising rates are being coupled with record-high home prices that, according to the Case-Shiller Home Price Index, show no signs of reversing (see chart below).
So you have fast-rising mortgage rates and soaring home prices. What else is there?
It’s not just home refinancing demand that is collapsing… as we noted yesterday, loan demand is tumbling everywhere, despite easing standards…
But seriously, who didn’t see that coming?
Having thrown in the towel on his bond bear market call two weeks ago, Janus Henderson’s billionaire bond investor Bill Gross now believes that the most recent bearish bond price (rise in yields) will stop here as the economy cannot support higher yields.
As Gross said two weeks ago, yields won’t see a substantial move from here.
“Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV.
“I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”
Since then, yields have tested the upper-end of his channel and are breaking out today to their highest since 2011 (10Y)…
and back to their critical resistance levels (30Y)…
Bill Gross thinks they won’t be right. He highlights the long-term downtrend over the past 30-years, which comes in a 3.22%.
“30yr Tsy long-term downward yield trend line for the past 3 decades now at 3.22%, only ~4bps higher than today’s yield.”
“Will 3.22% be broken to upside?” he asks.
“I don’t think so. The economy can’t support yields higher than 3.25% for 30s and 10s, nor 3% for 5s.
Continuing hibernating bond bear market is best forecast.”
Asa ForexLive also notes, if he’s right it doesn’t necessarily mean the US dollar will reverse right away but it would be a good sign for stocks and would limit how far the US dollar might run.
So, will Gross be right? Is this latest spike all rate-locks on upcoming IG issuance? And will this leave speculators with a record short position now wondering who will be the one holding the greatest fool bag by the end of the year…
Well worth your time to hear what geo-economic consultant Martin Armstrong has to say.
The Reserve Bank of Australia (RBA), Australia’s central bank, warns of a $7000 Spike in Loan Repayments as interest-only term periods expire.
Every year for the next three years, up to an estimated 200,000 home loans will be moved from low repayments to higher repayments as their interest-only loans expire. The median increase in payments is around $7000 a year, according to the RBA.
What happens if people can’t afford the big hike in loan repayments? They may have to sell up, which could see a wave of houses being sold into a falling market. The RBA has been paying careful attention to this because the scale of the issue is potentially enough to send shockwaves through the whole economy.
Interest Only Period
In 2017, the government cracked down hard on interest-only loans. Those loans generally have an interest-only period lasting five years. When it expires, some borrowers would simply roll it over for another five years. Now, however, many will not all be able to, and will instead have to start paying back the loan itself.
That extra repayment is a big increase. Even though the interest rate falls slightly when you start paying off the principal, the extra payment required is substantial.
For now, the RBA is unconcerned: “This upper-bound estimate of the effect is relatively modest,” the RBA said.
Good luck with that.
The Australian government has proposed a wide-ranging reverse mortgage plan that would make an equity release program available to every senior over the age of 65.
Previously restricted to those who partially participate in the country’s social pension program, the government-sponsored plan will extend to any homeowner above the age cutoff, according to a report from Australian housing publication Domain.
Under the terms of the government-sponsored plan, homeowners can receive up to $11,799 each year for the remainder of their lives, essentially taken out of the equity already built up in their homes. Domain gives the example of a 66-year-old who can receive a total of $295,000 during a lifetime that ends at age 91.
As in the United States, older Australians have a significant amount of wealth tied up in their homes; the publication cited research showing that homeowners aged 65 to 74 would likely have to sell their homes in order to realize the $480,000 increase in personal wealth the cohort enjoyed over the previous 12-year span.
In fact, the Australian government last year attempted to encourage aging baby boomers to sell their empty nests to free up the properties for younger families. Under that plan, homeowners 65 and older could get a $300,000 benefit from the government, a powerful incentive in a tough housing market for downsizers — and in a government structure that counts income against seniors when calculating pension amounts.
“Typically, older homeowners have been reluctant to sell for both sentimental and financial reasons,” Domain reported last year. “Often selling property is costly, and funds left over after buying a smaller home could then be considered in the means test.”
But the baked-in reverse mortgage benefit represents a shift toward helping seniors age in place instead of downsizing. The Australian government’s “More Choices for a Longer Life” plan also expands in-home care access by 14,000 seniors, according to the Financial Review, while boosting funding for elder physical-fitness initiatives and other efforts to reduce isolation among aging Australians.
The reverse mortgage plan will offer interest rates of 5.25%, which Domain noted is less than most banks, and will cost taxpayers about $11 million through 2022. Loan-to-value ratios are calculated to ensure that the loan balance can never exceed the eventual sale price of the home.
Greens leader Richard Di Natale has proposed a radical overhaul of Australia’s welfare system through the introduction of a universal basic income scheme, but critics believe this would only increase inequality.
Di Natale gave a speech at the National Press Club on Wednesday, outlining why he thought Australia’s current social security system was inadequate.
“With the radical way that the nature of work is changing, along with increasing inequality, our current social security system is outdated,” Di Natale said.
“It can’t properly support those experiencing underemployment, insecure work and uncertain hours.
“A modern, flexible and responsive safety net would increase their resilience and enable them to make a greater contribution to our community and economy.”
To address this, Di Natale called for the introduction of a universal basic income scheme, which he labelled a “bold move towards equality”.
“We need a universal basic income. We need a UBI that ensures everyone has access to an adequate level of income, as well as access to universal social services, health, education and housing,” he said.
“A UBI is a bold move towards equality. It epitomises a government which looks after its citizens, in contrast to the old parties, who say ‘look out for yourselves’. It’s about an increased role for government in our rapidly changing world.
“The Greens are the only party proudly arguing for a much stronger role for government. Today’s problems require government to be more active and more interventionist, not less.”
However Labor’s shadow assistant treasurer Andrew Leigh, responded on Twitter that Australia had the most targeted social safety net in the world and that Di Natale’s plan would increase inequality.
Leigh was unavailable for comment when contacted by Pro Bono News, but in a speech given at the Crawford School of Public Policy in April last year, he explained why he opposed a UBI.
“As it happens, using social policy to reduce inequality is almost precisely the opposite of the suggestion that Australia adopt a ‘universal basic income’,” Leigh said.
“Some argue that a universal basic income should be paid for by increasing taxes, rather than by destroying our targeted welfare system. But I’m not sure they’ve considered how big the increase would need to be.
“Suppose we wanted the universal basic income to be the same amount as the single age pension (currently $23,000, including supplements). That would require an increase in taxes of $17,000 per person, or around 23 percent of GDP. This would make Australia’s tax to GDP ratio among the highest in the world.”
Liberal Senator Eric Abetz described Di Natale’s plan as “economic lunacy”.
“Its catastrophic impact would see the biggest taxpayers in Australia, the banking sector, become unprofitable and shut down and his plan for universal taxpayer handouts would see our nation bankrupted in a matter of years,” Abetz said.
“This regressive and ultra-socialist approach of less work, higher welfare and killing profitable businesses has been tried and failed around the world and you need only look at the levels of poverty and riots in Venezuela.
“Senator Di Natale must explain… who will pay for this regressive agenda when he runs out of other people’s money.”
Despite this criticism, welfare groups said they welcomed a conversation on a “decent income for all”.
Dr Cassandra Goldie, the CEO of the Australian Council of Social Service, indicated that a UBI would be discussed among their member organisations.
“We are very glad a decent income for all is being discussed. Too many people lack the income they need to cover even the very basic essentials such as housing, food and the costs of children,” Goldie told Pro Bono News.
“We will be discussing basic income options with our member organisations.
“Our social security system has a job to protect people from poverty and help with essential costs and life transitions such as the costs of children and decent housing. It is failing at this. The basic minimum allowance for unemployed people is just $278 per week.
“Budget cuts – including the freezing of family payments – have made matters worse.”
Goldie said that working out if a basic income proposal would increase or reduce inequality depended on the detail.
“We don’t oppose universal payments on principle, but reform of social security should begin with those who have the least. This must be the first priority,” she said.
“The principle that everyone should have access to at least a decent basic income is a good starting point for reform. Let’s have that debate.”
The convenor of the Anti-Poverty Network SA, Pas Forgione, told Pro Bono News that a UBI would only address inequality if payments were set to an adequate level.
“If universal basic income means that everyone gets the same income that people on Newstart gets, roughly $260 a week, then I don’t think that’s going to do much to alleviate poverty,” Forgione said.
“It needs to be set at an adequate level. And I think that involves looking at what it takes to have a reasonable standard of living and a reasonable quality of life in a country like Australia. So it depends on the details.
“If it is set at an adequate level, than it would be a terrific thing for the quality of life for a number of very low income people. I’m not saying that it’s a panacea… but I think you could make a very strong case for looking at a UBI.”
Di Natale’s speech also called for the creation of a nationalised “People’s Bank”, to give more people access to affordable banking services and to add “real competition” to the banking sector.
“A people’s bank, along with more support for co-operatives and mutuals, would inject some real competition into the banking sector,” he said.
“We have a housing crisis that has been created by governments.
“So now is the time for government to step in: through a People’s Bank, by ending policies skewed in favour of investors like negative gearing and the capital gains tax discount, and through a massive injection of funds for social and public housing.”
When ZH reported Wells Fargo’s Q4 earnings back in January, they drew readers’ attention to one specific line of business, the one they dubbed the bank’s “bread and butter“, namely mortgage lending, and which as they then reported was “the biggest alarm” because “as a result of rising rates, Wells’ residential mortgage applications and pipelines both tumbled. Specifically in Q4 Wells’ mortgage applications plunged by $10bn from the prior quarter, or 16% Y/Y, to just $63bn, while the mortgage origination pipeline dropped to just $23 billion”, and just shy of the post-crisis lows recorded in late 2013.
Fast forward one quarter when what was already a grim situation for Warren Buffett’s favorite bank, has gotten as bad as it has been since the financial crisis for America’s largest mortgage lender, because buried deep in its presentation accompanying otherwise unremarkable Q1 results (modest EPS and revenue beats), Wells just reported that its ‘bread and butter’ is virtually gone, and in Q1 2018 the amount in the all-important Wells Fargo Mortgage Application pipeline failed to rebound, and remained at $24 billion, the lowest level since the financial crisis.
Yet while the mortgage pipeline has not been worse since in a decade despite the so-called recovery, at least it has bottomed. What was more troubling is that it was Wells’ actual mortgage applications, a forward-looking indicator on the state of the broader housing market and how it is impacted by rising rates, that was even more dire, slumping from $63BN in Q4 to $58BN in Q1, down 2% Y/Y and the the lowest since the financial crisis (incidentally, a topic we covered just two days ago in “Mortgage Refis Tumble To Lowest Since The Financial Crisis, Leaving Banks Scrambling“).
Meanwhile, Wells’ mortgage originations number, which usually trails the pipeline by 3-4 quarters, was nearly as bad, plunging $10BN sequentially from $53 billion to just $43 billion, the second lowest number since the financial crisis. Since this number lags the mortgage applications, we expect it to continue posting fresh post-crisis lows in the coming quarter especially if rates continue to rise.
Adding insult to injury, as one would expect with the yield curve flattening to 10 year lows just this week, Wells’ Net Interest margin – the source of its interest income – failed to rebound from one year lows, and missed consensus expectations yet again. This is what Wells said about that: “NIM of 2.84% was a stable LQ as the impact of hedge ineffectiveness accounting and lower loan swap income was offset by the repricing benefit of higher interest rates.” But we’re not sure one would call this trend “stable” as shown visually below:
There was another problem facing Buffett’s favorite bank: while NIM fails to increase, deposits costs are rising fast, and in Q1, the bank was charged an average deposit cost of 0.34% on $938MM in interest-bearing deposits, exactly double what its deposit costs were a year ago.
And finally, there was the chart showing the bank’s consumer loan trends: these reveal that the troubling broad decline in credit demand continues, as consumer loans were down a total of $9.5BN sequentially across all product groups, far more than the $1.7BN decline last quarter.
What these numbers reveal, is that the average US consumer can not afford to take out mortgages at a time when rates rise by as little as 1% or so from all time lows. It also means that if the Fed is truly intent in engineering a parallel shift in the curve of 2-3%, the US can kiss its domestic housing market goodbye.
In the latest quarter, the broker-dealer suffered a net loss of 145 brokers