Fixed rate mortgage (FRM) rates are finally on the rise from their recent rock bottom positions. In the past week, the average rate on a 30-year FRM loan shot from 5% to more than 5.3%. In a discretionary move, lenders eager to keep the mortgages rolling are quick to let borrowers know those 3% and 4% rates are still available – but only in the form of incremental short-term mortgages called an adjustable rate mortgages (ARMs).

These rising FRM rates are the result of the Federal Reserve (the Fed) returning to investors the open-market purchasing of mortgage-backed bonds, possibly due to the appearance that our economy is slowly moving upward. As the country’s financial situation begins to solidify and strengthen, government subsidy programs for real estate builders, lenders and sellers will start to recede. However, with these rising rates comes an increasing concern for prospective homebuyers, as they feel their potential buying power is diminishing with each passing moment.

For each percent mortgage rates rise, a buyer’s purchasing power is reduced by roughly 10%. Consider a homebuyer whose dream home is $300,000. Last week, at a 5% interest rate, the homebuyer qualified for a $300,000 30-year fixed rate mortgage with a monthly payment of $1,600 – 31% of his gross income. However, if that fixed rate rises but 1%, to a total of 6% (late 2010 or early 2011), that same homebuyer can still pay only $1,600 a month – 31% of his gross income – but he will now only qualify for a loan of $270,000. [For more information on the historical impact changes in the mortgage rate have had on buyers, see April 2010 first tuesday’s market chart Buyer Purchasing Power.]

Homebuyers are naturally becoming more anxious as they are being alerted to the sharp mortgage rate changes by their agents and brokers. With the rising rates, prospective homebuyers are being swayed to hasten their decision, and “Buy now!”

first tuesday take: The Fed was criticized when they began buying up all the mortgage-backed bonds in February of 2009 when open-market investors abandoned the purchasing of mortgage-backed bonds, and now the Fed is being criticized for ceasing this bond market subsidy too early.

Those who believe we will see an increase in consumer and real estate spending throughout 2010 are expecting to see the rate continue to rise – possibly as high as 6.5% by the end of 2010.

However, those who believe the sales volume of homes will slip during 2010 do not foresee rates hitting that 6.5% ceiling. 5.5% is more conceivable, and given the static state of the real estate market, rates (and current prices) will not drive demand much higher, if at all.

It is first tuesday’s belief that the current mortgage rate does not have the ability to maintain its current upward trajectory because California’s economy, and particularly the real estate market, is still lacking some foundational pieces for recovery: jobs and first-time homebuyers. A rise in these two factors is essential; without them we do not add to the number of actual home users, which prevents an increase in the volume of home sales to levels seen between 1999 and 2002.

Both jobs and motivation are required for tenants and investors to buy real estate. Currently, we do not have either of them (and the subsidies are not helping matters in the long run). So while mortgage rates have begun their necessary ascent for artificially low interest rates, they will not hit the roof until both the economy and the real estate market are in good health.

Presently, mortgage rates will not have a large effect on the real estate market, but our market will affect the rate. That affect, for now, is keeping rates lower than anticipated several months ago.

Re: “Homebuyers scramble as mortgage rates jump” from the Washington Post

Tagged as: mortgage rate, fixed rate, 30-year loan