The Fed raised the Fed Funds Rate by 0.25% on Wednesday – the first increase since December 2015 – and the Federal Open Market Committee (FOMC) has indicated by way of its “dot plot” that two, possibly three more increases are expected in 2017.
The FOMC’s statement and comments made by Fed Chair Janet Yellen following the announcement, however, didn’t really give any indication as to the timing of the increases. Most mortgage and housing experts interviewed by MortgageOrb say they expect only two rate increases in 2017 – one mid-year and another in the fourth quarter – however, the FOMC will evaluate the usual macro-economic indicators before making any decisions.
The big question, of course, is whether these additional increases will actually occur and, if so, in which months? Masking the impact is the fact that mortgage rates were already on the rise, prior to the Fed’s decision, so the more general question is, what impact will a rising rate environment have on housing and the mortgage industry?
“The Federal Reserve’s 0.25% rate hike really shouldn’t have a major impact on either mortgage rates or on the overall housing market,” says Rick Sharga, executive vice president of Ten-X. “But it will probably have an impact on both anyway.”
“Mortgage rates really aren’t tied directly to the short-term benchmark rate – they tend to rise and fall more in tandem with the yields on longer-term U.S. Treasury bonds,” Sharga explains. “But we saw a one-point increase in the rate for 30-year fixed rate loans after the Fed raised rates by 0.25% last year, followed by a dramatic drop-off in loan applications. Hopefully, lenders learned from this, and will approach any rate increases this time more cautiously. It’s also very possible that recent increases in mortgage rates may have already ‘baked in’ an anticipated Fed funds rate increase.”
Sharga says even if mortgage rates do go up marginally, “they shouldn’t have a significant effect on affordability or housing demand, although there may be a short-term psychological impact for borrowers who have become used to living in an historically low interest rate environment.”
Borrowers, he says, need to keep two things in perspective.
“First, that rates remain very near their low-water mark – the 25-year average rate on a 30-year fixed-rate loan is 8.25%, nearly twice what the average borrower is paying today,” Sharga says. Second, the actual impact on a monthly payment is minimal – the difference per $100,000 on a loan at 4.0 percent versus 3.5 percent is $26 a month. We’ll likely see a drop-off in loan applications – exacerbated a bit by seasonality – followed by an up-tick caused by buyers opting to move on homes before rates go up further. Assuming that rates hold at their new levels or go up a bit more, we’re likely to see home price appreciation slow down, so affordability shouldn’t change dramatically.”
Sharga says there is no question that increasing rates, whether caused directly or indirectly by the Fed’s move, will impact the refinance market.
“The number of borrowers who’d benefit from refinancing a loan into a new 4.25 percent loan is significantly lower than the number who’d benefit at 3.50 percent,” he explains. “If the Fed does indeed raise its rates two to three times in 2017, and mortgage rates rise along with them, this will have a huge impact on originators who depend on refinances as a big part of their business.”
Sam Heskel, CEO of Nadlan Valuation, says the rate hikes “will have some negative effect on the mortgage business, definitely more on refinances than purchase loans.”
“But rates have been rising for the past five months, so the Fed is just recognizing market reality,” Heskel says. “Developers and builders will pay a little bit more to finance new projects, which could slow commercial development and residential building, but I don’t see it as having a huge impact.”
“I think eventually rates will plateau,” Heskel adds. “They’ll be higher than they have been the past few years, but still low by historic standards. Ironically, higher rates may actually have a positive effect on the home purchase market by forcing house prices to moderate, which could help more people afford homes than low rates did.”
Rick Roque, president and founder of MENLO, a firm that advises mortgage lenders on their M&A strategies, says although the increase will undermine both refinance and purchase activity, “it may provide a short-term spike in purchase originations, motivating on-the-fence buyers to take action.”
“Still, the Mortgage Bankers Association’s prediction that originations will drop 38 percent next year is likely based on an assumption that the Fed will raise rates at least three times in 2017, since these tend to have a dampening effect on mortgage origination,” Roque says. “Further, these rate hikes will drive further industry consolidation. Wholesale lenders, correspondents and servicers that have attempted to get into retail will get out, shut down or sell their companies. As a result, this is going to drive M&A activity and company valuations down. Further, we will see compression in what loan officers are paid. Sign-on bonuses and compensation will normalize and go down because there will be less profit and less margin. Companies will increase margins to offset lower production volumes.”
Neil Garfinkel, managing partner with Abrams Garfinkel Margolis Bergson, LLP (AGMB), says the hike has already helped push mortgage rates to the highest levels this year.
“Freddie Mac announced that, for the week ended December 15, the 30-year fixed-rate mortgage (FRM) averaged 4.16 percent, up from 4.13 percent the previous week and 3.97 percent the same week last year,” Garfinkel says. “The 15-year FRM averaged 3.37 percent, which is higher than last week’s rate of 3.36 percent and last year’s rate of 3.22 percent. The average interest rate for a 5/1 adjustable rate mortgage also peaked at 3.19 percent – higher than the previous week’s rate of 3.17 percent and the year-over-year rate of 2.67 percent.
“The higher interest rates are already having an impact in loan originations and refinancing,” Garfinkel says, adding that a report from the Kroll Bond Rating Agency predicts a 20 percent drop in loan origination volume in 2017 and a decrease in refinancing volumes from $263 billion this quarter to $145 billion in the first quarter in 2017. “If people are considering refinancing, they should do it now.”
Meanwhile, the National Association of Realtors (NAR) is forecasting that existing home sales in 2017 are going to be basically flat compared with 2016, due to increasing mortgage rates and shrinking consumer confidence that now is a good time to buy a home.
“Rents and home prices outpacing incomes and scant supply in the affordable price range has been a prominent headwind for many prospective buyers this year,” says Lawrence Yun, chief economist for NAR, in a statement. “Making matters worse, the unwelcoming reality of higher mortgage rates since the election is likely further holding back confidence. Younger households, renters and those living in the costlier West region – where prices have soared in recent months – are the least optimistic about buying.”
NAR is currently forecasting that existing home sales in 2017 will reach about 5.52 million, which is only a 2% increase compared with this year.
“Although the economy is expected to continue to expand with around 2 million net new job creations, existing home sales are expected to see little expansion next year because of affordability tensions from rising mortgage rates and prices continuing to outpace income growth,” adds Yun.