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What Rising Rates Mean for the Housing Recovery 

Kristina Hooper 

The Upshot 

Kristina Hooper

7/29/2013 

Talk of tapering has spooked investors and sent mortgage rates higher. But does it throw cold water on the housing rebound? Kristina Hooper explains why the recovery is still intact.
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Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Historically low mortgage rates have been a key driver for the housing recovery. But since the Federal Reserve hinted at an unwinding of its asset-purchase program, rates have jumped significantly. The pace of the housing rebound is likely to slow down in the short run based on concerns over an end to QE, but the case for continued progress on the home front remains intact.

Last week, we saw both anecdotal and statistical evidence that this uncertainty over mortgage rates is taking its toll on housing. Several home builders said that orders in the second quarter were negatively impacted by rising rates. That comes on the heels of data released the previous week showing that housing starts in June had retrenched sharply, falling 9.9%.

But a closer look would caution against ringing the alarm bell on housing. First, we need to separate refinancing activity from home purchases. While refinancing activity is likely to slow in the near term, home purchases, and therefore home prices, are not. That's because consumer sentiment is positive and housing supply is relatively tight:

The July Thomson Reuters/University of Michigan index of consumer sentiment rose to 85.1 in July—a six-year high. The reading was well above expectations and up from 84.1 at the end of June.

The National Association of Realtors reported last week that total housing inventory in June climbed 1.9% to 2.19 million existing homes. This means there's a 5.2-month supply of houses at the current sales pace, which is up from 5.0 months in May but it's still 7.6% below year-ago levels, when there was a 6.4-month supply.

Inventory, at the current sales rate, is even tighter for new homes at 3.9 months.

However, that's not to say that there won't be any volatility in demand for homes, but that demand will likely trend higher because housing affordability—the combination of home prices, lending rates and consumer wages—is so attractive in relative terms. While June existing-home sales came in at 5.08 million annualized and home prices fell 1.2% from last month, existing home prices have risen 15.2% in the past year.

Underwater

That brings us to a second discussion on refinancing activity. While refinancing applications have declined recently—they're at a two-year low—there's room for refinancing activity to increase in the future. That's because many US homeowners with mortgages haven't been able to take advantage of the low rates we've seen in the past few years. Consider that 19.8% of all residential homeowners with mortgages—9.7 million—have negative equity. And there are even more homeowners with mortgages—23% or 11.2 million—that have less than 20% positive equity. Many, if not all, of these folks have been unable to refinance because of stricter underwriting standards.

Upside Down Chart

When you add them up, that's more than 42% of homeowners with mortgages that are either underwater or have positive equity of less than 20%. That means there's a large group of homeowners that likely has existing mortgage rates of 6% or far higher and would jump at the chance to refinance even if mortgage rates rise above 5%g—assuming they have enough equity. With home prices rising and the number of homes moving into positive equity territory increasing each month—in the past year, 1.7 million borrowers regained positive equity—sooner or later these homeowners will likely qualify for refinancing at current rates. The result: A significant increase in refi applications and more spending money.

The housing outlook is far from bleak. While momentum is likely to slow, there remain important reasons why demand will continue to grow along with home prices, which could boost refinancing activity over the longer term. And in the unlikely event that the housing recovery does stall, remember what Fed Chairman Ben Bernanke said: "If we think the mortgage rate increases are thwarting the progress, we will have to take additional action." In an era of financial repression, there's always the possibility the Fed will dial up the stimulus.

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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, us.allianzgi.com, 1-800-926-4456.

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