Could mortgage rates soon hit 5%? We’re not that far off

Applications for purchase-money loans are down 40% from a year ago, a key indicator homebuyer interest is waning as rates rise.

By Jeff Lazerson | jlazerson@mortgagegrader.com | MortgageGrader.com | April 02, 2021

Home buyers needing financing may have hit a pay wall as mortgage rates rise more than one percentage point in just eight weeks.

The average rate for a 30-year fixed-rate mortgage hit 4.67% on Thursday, March 31, according to Freddie Mac. That’s 1.5 percentage points higher than a year ago. And rates are more than 2 points higher than the all-time Freddie Mac low of 2.65% just 15 short months ago.

A key indicator of homebuyer interest is purchase mortgage applications. Applications are down an astounding 40% from a year ago, according to the Mortgage Bankers Association.

“We are at a turning point in the market. Offer activity is slowing,” said Patrick Veling, president and CEO of Real Data Strategies. “Homebuyers, especially in the $1.1 million to $1.4 million price range, are saying we’re mad as hell and we’re not going to take it anymore.”

Nationally, home prices were up 19.2% year-over-year in January, according to the S&P/CoreLogic Case-Shiller index.

The annual inflation rate was 7.9% as of February, according to the Labor Department. Consider how true home affordability squares with inflation.

Let’s say someone put 20% down on a $500,000 starter home a year ago. The principal and interest payment on $400,000 at the Freddie Mac rate of 3.18% a year ago would have been $1,725. Add $125 per month for insurance and 1.25% for property taxes, and we arrive at a total payment of $2,371.

Assuming a 19.2% home price increase, we are looking at a sales price of $596,000. Assuming 20% down, we have a $476,800 loan amount at today’s Freddie Mac rate of 4.67%. The principal and interest payments are $2,464. Add $135 (assuming a 7.9% inflation rate) for insurance and $621 for property taxes, and we land at a payment of $3,220, or $849 a month more.

That’s a one-year increase of almost 36%. How does that square with a 7.9% inflation rate?

Real average hourly wages decreased 1.3% from January 2021 to this past January, according to the U.S. Bureau of Labor Statistics. Cleary, the pandemic is at play regarding the job market. Home affordability becomes even more constrained.

“We have excess demand over supply causing prices to rise,” said Ted Tozer, former Ginnie Mae president under President Obama. “The goal is supply and demand equilibrium.”

While Tozer believes the economy is very strong, he points to Fed Chairman Paul Volker raising short-term rates to 20%, with mortgage rates rising to 15%. Volker purposely pushed the U.S. into a recession to reduce demand.

Another sign of a softening market? Inventory is becoming a mixed bag, at least locally.

For-sale home listings are down 25% from a year ago in Los Angeles County and down 34% in Orange County, according to Steven Thomas of Reports on Housing. At the same time, supply is up in the Inland Empire, rising 31% in San Bernardino County and 4% in Riverside County.

What does all this mean for home prices?

Michael Pento, president and founder of Pento Portfolio Strategies, believes the Labor Department will report next month that March’s inflation rate is up 9%. He also sees a recession coming, citing the recent inversion of the 10-year and 2-year yield curves and aggressive Fed action to raise short-term rates.

As a result, he said, home prices could drop at least 20% next year.

“The Fed must tighten interest rates to get inflation under control,” Pento said. “We are on a fiscal and monetary cliff. The Fed has to go from quantitative easing to quantitative tightening. (There was) $800 billion on the Fed balance sheet in 2008, and (there’s) $9 trillion today.”

Not everyone foresees a home-price drop.

Mark Vitner, senior economist at Wells Fargo, thinks property will appreciate 10% in 2022 and 7% in 2023. But he’s worried the Fed is trying to do too much too fast, pushing the U.S. economy into a recession.

“The fight to contain inflation will be a multi-year project,” said Vitner. “I think the 30-year fixed will come back down this year.”

Most experts I polled expected mortgage rates to land somewhere around 4.5% for a 30-year fixed by the end of 2022. We already exceeded that rate at 4.67%, and we are just completing the first quarter.

Could we soon see 5% fixed rates? We’re not far off.

If the exotic mortgage market is any indication, we are going to hit 5% and then some in the conventional mortgage market. The outside-the-box, so-called non-qualified mortgages are already north of 6% for a 30-year fixed. Yikes.

Mortgage lenders are pretty shaken these days. On top of a dearth of homebuyer applicants, refinance volume is down 60% from a year ago, according to the Mortgage Bankers Association.

There will always be motivated buyers in some form.

“Assuming rates stay around where they are, the (home) supply constraints will keep prices from falling,” said Veling. He sees home appreciation dropping from 19% to 8% or 9%.

Buyers are seeking lifestyle over the next 18-to-36-month time horizon-not appreciation, according to Veling.

“They are having families and wanting to raise families in a home.”

Freddie Mac rate news: The 30-year fixed rate averaged 4.67%, 25 basis points higher than last week. The 15-year fixed rate averaged 3.83%, 20 basis points higher than last week.

The Mortgage Bankers Association reported a 6.8% decrease in mortgage application volume from the previous week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $647,200 loan, last year’s payment was an eye-popping $553 less than this week’s payment of $3,345.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages without points: A 30-year FHA at 4.125%, a 15-year conventional at 3.875%, a 30-year conventional at 4.375%, a 15-year conventional high-balance ($647,201 to $970,800) at 4.675%, a 30-year conventional high-balance at 4.875% and a 30-year fixed purchase jumbo at 4.25 %.

Eye-catcher loan of the week: A 30-year purchase, adjustable jumbo mortgage for up to $5 million with a half point cost, locked for the first five years with at 3.125%.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.