In each Economic Update, the Research staff analyzes recently released economic indicators and addresses what these indicators mean for REALTORS® and their clients. Today’s update discusses the latest mortgage applications data.
- Seasonally adjusted applications to purchase homes rose 1.5% in the week ending January 24th compared to the prior week. The purchase index is roughly 12% lower than the same time in 2013. Last week’s improvement comes after a 3.5% drop in the prior week. Purchase applications have been volatile after a sharp increase in the week prior to the implementation of the new qualified mortgage rule two weeks ago.
- The Qualified Mortgage rule went into effect for all applications received on or after January 10th. The “QM” rule introduced stronger underwriting, fee and pricing protections for consumers, but those protections could also raise costs or limit credit access for some consumers.
- The average rate for a 30-year fixed rate mortgage as reported by the Mortgage Bankers Association eased five basis points from the prior week to 4.52%, and has eased nearly 14 basis points in the last 2 weeks.
- In a bit of a surprise, new purchase applications for conventional mortgages eased 0.3% following a decline of 2.9% in the prior week, but applications for government financing jumped 5.8%, bettering the prior week’s decline of 5.2%. This shift could hurt the relatively nascent revival of the private mortgage insurance business if it is sustained.
- Mortgage applications have been volatile since the implementation of the new qualified mortgage rule two weeks ago. Since then mortgage rates have eased helping to buttress applications. What’s more, the MBA’s index reflects a larger mix of retail lenders than small and mid-sized independents whose influence grew in the last two years as a result of the refinance boom. The qualified mortgage rule is likely to have a stronger impact on these small to mid-sized mortgage originators as they are not exempt from the rule nor do they have the deep legal resources to move aggressively in this new regulatory environment as many of the larger retail operations would. As a result of these two factors, this week’s reading may mask to some extent shifts in the market. Still, applications reflect the same moderate downward trajectory relative to last year as foot traffic, pending home sales and existing homes sales have displayed in recent months.
The sharp rise in mortgage rates from May to July of this year presents an opportunity to reflect on the merits of one pillar of the US mortgage finance system; the 30-year fixed rate mortgage. The 30-year FRM has many positive and a few negative qualities, but its role in the U.S. system is central and provides consumers with multiple important benefits. Additional options and alternatives for a stable long-term financing product could only benefit the system, but it is important to maintain one that works.
Mortgage rates will continue to rise. They will probably be near 5 percent by this time next year, compared to the 3.5 percent average of the past 12 months. The rates will be even higher in 2015 and 2016. Certainly, rising rates are bad news for buyers and some potential homebuyers will be pushed out of the market. For example, the number of renter households that have sufficient income to buy a $177,000 home at a 3.5 percent mortgage rate is 17.8 million. The number drops to 14.9 million at a 5.0 percent mortgage rate, which is a decline in percentage terms of 16 percent.
But there is one major compensating factor that can easily neutralize the negative impact of rising rates. As REALTORS® well know, there are many good potential buyers who have been denied a mortgage that in past normal years would have easily qualified. The comparison is with normal years and not the bubble years of no standards whatsoever. The Federal Reserve has also often commented about the excessively tight underwriting standards in today’s mortgage market. At the same time, banks have been reporting a strong profit growth from mortgage originations due to exceptionally low default rates on recently originated mortgages, particularly since 2010. Such well-performing recent mortgages should not be surprising since defaults do not happen in an environment with rising home prices. It appears then more loan originations, at least at the margin, will bring more profits for the lenders and correspondingly bring more buyers out into the marketplace. My estimation says there would be an additional 15 to 20 percent more homebuyers who qualify by returning to normal underwriting standards from the current very tight conditions. The table below shows the average credit score of those who obtained mortgage approvals in recent years. The credit scores are much higher now than in past normal times. So, for example, someone with a credit score of 730 would have had no trouble obtaining a Fannie-backed mortgage in the past, but is currently getting denied today.
There are other factors that can also help alleviate the rising interest rate conditions. The economy is adding jobs. A total of 2 million net new jobs were added in the past 12 months and another 2 million new ones are likely over the next 12 months. More jobs always lead to more home sales as long as rates do not spike.
Furthermore, there could be room for a reduction in fees associated with obtaining government-backed mortgages. The high profits generated by Fannie and Freddie in recent quarters are implying excessive add-on fees charged to consumers by these two effectively government agencies. A pure for-profit company should have the right to innovate and earn any profit it can obtain as long as there are no barriers to entry into the business. But Fannie and Freddie, as we have learned, are not and should not be for-profit entities. They got into a mess because of the hyper-gambling mindset of “heads we win and tails taxpayers lose”. Fannie and Freddie need to stick to the simple business plan of guaranteeing soundly underwritten, mostly boring 30-year mortgages, as they are currently doing. These simple 30-year fixed rate mortgages served our grandparents well and they subsequently will serve our grandkids well. No major innovation is required, which is the reason why being an effectively government agency can work fine. (We should, however, never trust the government to come up with an innovative product. Today’s iPhone and similar competitive products are worlds apart from the phones that our grandparents used.) The point is that Fannie and Freddie are making good profits now. They should first speedily repay the taxpayer bailout money. But afterwards, excess profits only mean excessive consumers fees. So a reduction in fees in the near future should occur, just in time to help offset the higher mortgage rate environment.