June 14th, 2007 10:35 AM by Karyn Smith
NEW YORK (CNNMoney.com) -- The recent run-up in bond yields isn't just fueling a stock selloff on Wall Street. It's nearly certain to batter already battered home prices on Main Street.
Mortgage rates follow bond yields closely, and economists say that the recent run-up in rates in the bond market will further erode what home buyers can pay for houses. Mortgage rates hit a 10-month high last week and are likely to climb further still - the latest bad news for the nation's troubled housing market.
"It's just what the housing market did not need," said Bill Hampel, chief economist at Credit Union National Association. "It wasn't on life support, but this will keep it bed-ridden for that much longer. When you're already fragile, this is not what the doctor ordered."
Last week, mortgage financing firm Freddie Mac said the average rate on 30-year fixed-rate mortgages jumped to 6.53 percent, the highest since August, and up from 6.15 percent only four weeks earlier. It was the biggest one-month jump in three years on the most closely watched mortgage product in the country.
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That increase in mortgage rates has cut the amount potential buyers can borrow by almost 4 percent while keeping their monthly payments the same. That means someone who could borrow $100,000 at 6.15 percent can now borrow only $96,086 at 6.53 percent.
That will only add to the downward pressure that has sparked the biggest drop in existing home prices on record.
"What people have been doing for the last five years is stretching to the limit on their mortgage loans," said Hampel. "If people are already stretched, the rise in rates flows straight through to the amount of money that people are able or willing to take on."
Since Freddie Mac's report on mortgage rates last week, the yield on the benchmark 10-year Treasury note has continued to rise.
David Berson, chief economist for mortgage finance firm Fannie Mae, said he expects the 30-year mortgage rate to rise to 6.65 percent to 6.70 percent this week, which would drop the amount a buyer can borrow even further - to about $94,413 at 6.70 percent, from $100,000 at 6.15 percent.
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"If the rise in rates was due to stronger economic growth, then it might not hit the housing market at all because stronger job growth might offset the higher rates," he said. "But that's not what's happening here. It's a change in perception of Fed policy (on interest rates). That's unambiguously negative for housing."
Berson noted that rising rates are probably not the most serious issue facing the housing market right now, but that's only because things like the glut of homes on the market are a more serious drag.
"It's gone up by roughly a half point in a month. That's noticeable but it's not huge," said Berson.
The jump in long rates has been steeper than the rise in short-term rates, widening the spread between 30-year fixed-rate home loans and adjustable-rate mortgages, or ARMs. The Freddie Mac survey showed the average 1-year ARM rate at 5.65 percent last week.
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But Hampel said the meltdown in subprime mortgages has focused attention on homeowners who can no longer afford their house payments after their ARMs reset. That could scare some people off from ARMs.
"ARMs have gotten a bad name in the last year," said Hampel. And he said some lenders now have tighter underwriting standards on ARMs, making sure a borrower can afford the payments at the highest possible rate before they qualify.
The run-up in mortgage rates can lead to a short-term jump in sales, rather than a drop, as would-be buyers jump in to lock in rates before they move higher, said Lawrence Yun, senior economist with the National Association of Realtors.
That may have been seen in the Mortgage Bankers Association figures Wednesday that showed U.S. mortgage applications rose for the first time in three weeks in the week ending June 8.
But Yun agreed with the other economists that the rise in mortgage rates is a negative for the housing market, though he said he would want to see if rates stay higher before he adjusts his forecasts for sales and prices.
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"We did anticipate the rates would rise. What's surprising is this quick of a movement this early," he said. "In terms of the overall housing market, generally it takes about three months for home sales to be affected by rising rates. I'm not sure if rising rates are sustainable. They sometimes overshoot one way, and then they swing back the other way."
Yun said rising rates are the biggest problem in the nation's higher-priced real estate markets, where affordability has already become an issue.
"The mortgage rate is far more important in the high priced regions of the country and that's the part of the country undergoing the slump," said Yun. "The rate change doesn't have as great an impact in Columbus, Ohio, or Kansas City, where home prices are more affordable with the local income levels."