Don't Expect 3 Percent Mortgage Rates

Many consumers who sat on the fence instead of buying a home and perhaps even more homeowners who procrastinated about refinancing, have been priced out of the market by higher interest rates.

And that's not the bad news. Interest rates are forecast to get higher, dig into housing affordability and lower the boom on even more housing consumers.

The average interest rate on the 30-year fixed rate mortgage (FRM), the most popular mortgage, has risen a full percentage point since it hit a record rock bottom low of 3.31 percent the week ending Nov. 21, 2012, according the Freddie Mac's Weekly Mortgage Market Survey.

This year, the 30-year FRM average has been as low as 3.34 percent, the week ending January 3 and 3.35 percent on May 2.

By June 27 the rate hit an average 2013 high of 4.46 percent and then dropped back to average 4.29 percent July 3.

But, with much of the interest rate increase in a short six-week period, from May to June, the damage was done.

For buyers, a $200,000 mortgage at 3.34 percent (this year's low) costs about $880 a month in principal and interest payments. For the same mortgage at the July 3, 4.29 percent rate, it's about $990 a month, according to LendingTree.com's mortgage calculator.

For some buyers, that $110 a month difference is enough to throw debt-to-income (DTI) ratios out of whack and shove a home purchase out of reach.

Buyers who want to maintain a qualifying DTI ratio, will have to jump through some financial hoops and document more income or fewer debts or both.

Because lenders want to see long-term sustained income, paying off debts may be some buyers' only option.

For a refinancing homeowner whose goal is to lower payments, the higher monthly mortgage cost could kill the deal.

Right now, for qualifying homeowners with rates of say, 5 percent to 5.5 percent or higher, a refinance for lower payments can still fly.

In any event, for any housing consumer who largely bases his or her decision on mortgage rates, there's not a lot of time to mull it over.

Impact of rising rates bad, good

Capital Economics (CE) puts it bluntly: "Higher mortgage rates are here to stay."

In late June, CE reported much of the rise in interest rates is due to anticipation that the Federal Reserve will begin to wind down its economic stimulus efforts sooner than expected.

That's already causing investors to flee the relative safety of U.S. Treasury bond investments, to which mortgage rates are tied. Generally, as goes the bond market, so go mortgage interest rates.

CE says recent sell offs in the bond market has already played havoc with the benchmark 30-year FRM with rising bond yields pushing up interest rates.

"Our new forecasts for Treasury yields suggest that this rise will not be reversed and will in all likelihood be extended. We are now penciling in 30-year mortgage rates of 4.5 percent at year end, rising to 5 percent next year and 5.5 percent in 2015," CE reports.

The higher rates can help stem the tide of rising home prices by making housing less affordable, effectively taking some of the steam out of the market.

Based on CE calculations, a mortgage payment as the share of the median income will increase from about 14 percent today to around 16 percent by the end of 2015.

But that doesn't mean the recovering housing market will hit a wall. The long-term average mortgage payment as a share of income is 22 percent, much higher than the immediate forecast.

Affordability should remain intact in the near future for the greater share of housing consumers.

CE says mortgage rates would have to rise to about 7 percent or the market would have to continue its double-digit run up in home prices before affordability really took a hit.

However, a combination of much higher interest rates and continued double-digit home prices increases could spell doom for the housing market, according to CE.

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