As investors begin to show signs of nervousness about backing government debt, historically low mortgage rates could feel the impact, further curbing South Florida’s shaky low-end market pickup.
“Essentially, we’re seeing more and more aversion to taking on longer term mortgage risk,” said Michael Larson, an interest rate and real estate analyst with Jupiter-based Weiss Research.
Larson predicts that rates will continue to creep past 5.5 percent within a few months. The higher rates equate to more of a U-shaped housing recovery, Larson said. “I don’t think this will be like 1982 when we had double-digit rates,” he said. “But the rates will get higher, and that will be a problem for a housing market that is still weak.”
Investors buying bonds guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae want a higher return for financing government debt because of several factors. A federal budget deficit of nearly $2 trillion, with other huge deficits to come, is believed to be inflationary, and investors demand higher interest rates to compensate for the inflation risk, Larson said.
There are also concerns that the Federal Reserve will have to eventually sell off $507 billion in mortgage-backed securities it recently purchased to try to keep home loan interest rates down. A massive government liquidation would flood the bond market with an over-supply of mortgage-backed securities, driving down bond prices and pushing up loan rates. Foreign investors are also worried bonds could yield less return as the U.S. dollar declines.
“You have different forces at work, but they are all pushing the yield in the same direction,” Larson said.
On May 27, mortgage bond yields for Freddie Mac and Fannie Mae reached their highest level since late February. Rates soon followed. The following day, loan rates went up 1/2 percent for a 30-year fixed mortgage. As of June 3, the 30-year, fixed-rate loan averaged 5.29 percent nationally, according to data from Freddie Mac.
Richard Hanley, a Stonegate Bank senior vice president for residential lending for the Miami and Fort Lauderdale area, describes the situation as “a little bit of the dam breaking.”
“The mortgage-backed securities imploded,” Hanley said. “It has leveled off a little since then, but that was the market telling the government, ‘We don’t believe you are keeping the rates down.’ There is too much debt that has to be sold off by the Fed.”
The more rates rise, the less purchasing power homebuyers have. For a $200,000 home loan the difference between a 5 percent and a 5.5 percent rate is $22,000 over the 30-year life of a loan.
Hanley expects rates to stay above five percent over the next few months. “Historically they are still wonderful,” Hanley said. “It’s just that over the last few months, people got used to seeing a four on the rate sheets.”
One of the first impacts will be a slight uptick in home refinancing as owners who have been sitting on the fence decide now is the time to refinance, Hanley said.
Then comes the more drastic slowdown in refinancing.
As rates increase, the projected average lives of mortgage bonds and loan-servicing contracts extend — as estimated refinancing drops — leaving investors with portfolios of longer than projected duration. Holders could then seek to sell some Treasury securities and mortgage bonds, sending yields even higher.