Will Mortgage Rate Drop Stimulate the Market?

Mortgage rates have been all over the map for the past week, since the Fed's .75% drop in the Fed funds rate. Today, I checked mortgage rates at Schwab (yes, Schwab Bank does mortgages). The 30 year fixed conforming (less than $417,000) was 5.596% and the 15 year fixed conforming was below 5%, at 4.943% with 0 points. (Note: these are rates, not APRs that take into account application fees. I tend to look at Schwab for rates, because they're one of the few lenders online that quote rates without points, even though almost all lenders offer 0 point loans.)

Market watchers anticipate that the Fed will cut interest rates again at its meeting this week, which could translate into even lower mortgage rates. (Note that the Fed rate cuts apply to short term rates, and mortgage rates are tied more closely to the 10 year Treasury, so a half point Fed cut doesn't mean there will be a half point drop in mortgage rates, but a Fed cut will likely mean some drop in mortgage rates.) Its possible that we could see the 30 year fixed conforming rate drop into the 5 1/4 to 5 3/8 range in the very near future, with the 15 year falling below 4 3/4%.

Its going to be interesting to see if lower rates will stimulate the real estate market. One thing I've been seeing lately is negotiations for homes here stalemating with relatively small gaps between buyers and sellers. If money is 10% or 15% cheaper than a month or two ago, which translates into lower carrying costs, will that motivate buyers to 'bite the bullet' and make the deal, even if its a little more than they were hoping to pay?

As an aside, I'm buying a studio coop in the Bronx. I went into contract for it about 6 weeks ago and went the route of a studio rather than a one bedroom because I was nervous about the market, didn't want to spend a lot, and decided to pay cash. But I have to say that if mortgage rates had been down around 5%, rather than above 6%, I probably would have sprung for a larger, more expensive apartment and gotten a mortgage. There are two important cost factors in real estate --- the cost of the real estate itself, and the cost of the money to buy it. Buyers have been focused on the real estate side, holding out for bargains. But the big bargain may be on the money side.

Comments

[DSS]

Since it was artificially cheap money that helped inflate the housing bubble, I don't understand how more of the same is a sensible remedy. Unless you're a real estate broker or a builder. . . .

[David Knudsen]

DSS, I don't think the mortgage crisis was a function of the money being too cheap, but rather the underwriting standards being too loose. Sure, cheap teaser rates for subprime borrowers created the illusion they could afford more than they could --- but that's very different than lower fixed rates for qualified borrowers. The era of bait and switch and teaser rates to get marginal borrowers to stretch for more home than they can afford is over.

[CP]

Right on David - low rates, and a return to sane pricing (no your house isn't guaranteed to go up 10% a year) and tight and tradition underwriting, is a good start to stemming the fear of buying. Rates in the 5% range is, historically, free money.

But like you said, if underwriting stays stringent (like it used to always be), low rates are nothing but a good thing for qualified buyers and current homeowners.

DK, you should have used the cash to buy that stretch pimped out van and driver to drive your customers around that you were talking about last year.

[DSS]

DK -- As if to prove my point, we have a post from a builder cheering you on! I think the "mortgage crisis" and the housing bubble are two distinct phenomena -- related, to be sure, but not one and the same. The mortgage crisis, as you recognize, resulted from imprudent lending. And such lending did feed the bubble. But quite apart from sketchy underwriting, the bubble was also fueled by Greenspan's policy to suppress rates. The result was artificially cheap money that encouraged even qualified borrowers (perhaps qualified borrowers especially) to pay too much for houses in relation to historical metrics. And that's one thing I fear about the impact of the Fed's recent moves on mortgage rates -- that it will reinflate the bubble. I look around Sullivan County and see house after house languish on the market, sometimes for years. These are not foreclosures and they are not all "crap" houses. They are the debris of a burst bubble. Reinflating the bubble would benefit brokers and builders, but not buyers.

[JM]

Dave, The answer is clearly NO from an economist's view.

Even if interest rates are driven down to 1% (which I think will happen with the fed) or even close to 0% (Japan did that for 14 years of deflation), we are looking at the worst housing deflation in American history. Buyers still must pay back the excess principal, even if interest-free! Remember zero interest for 60 mos. on american cars after 911? It helped buyers a litle but we weren't in a recession then. Social psych was filled with "go out and buy".

The next 20 years are going to be very turbulent times for the USA. Baby-boomers retiring and they will be flooding the market with housing to sell or passing it to their kids (who will either keep it or sell it). There will be great excesses in real-estate. We may not see another housing boom for a very long time.

In regards to the catskills buyer from NYC: the 'dumb money' that thinks they were getting a steal when they bought 5 acres for 50K are droping out of the market faster than falling house prices.

This summarizes Housing in USA:

http://www.businessweek.com/magazine/content/08_06/b4070040767516.htm

[GNN]

JM- Thanks for posting the BW article. I agree with you and the view in the article. Especially the commentary that this correction needs to simply run its course (like holland tulips, stocks in 1929 and 1999, etc.). However, given that this is an election year, it looks like the current powers will do anything to avoid (or more accurately, to delay) a major recession in 2008. Tax rebates, mortgage interest breaks, interest rate cuts, etc. will only work in the short run to buoy financial markets and delay the inevitable correction that needs to take place in this economy. Just look at the market reaction to the employment numbers today !! People are clearly out ahead of their ski's and delay as we might, a day of reckoning is well overdue and very much needed. The incoming president will bear the brunt of the excesses of today and the past 8+ years. The re market needs to reset and then form a stable base closer to a healthy balance. As a buyer on the sidelines, I am anticipating that second home prices will ultimately revert to the mean and settle in well below going rates. Honestly, does it make any sense that I need to pay more for a second home with much smaller square footage than I paid for my primary residence only 9 short years ago ?? How can my 5 bedroom/3.5 bath house only 20 mins from Manhattan cost me about half of what a 3 bedroom/1 bath lakefront home would cost me today? Sorry David, the math just doesn't work...even with lower rates.

[TR]

Consider that 'second home' properties (weekend, retirement, etc.) should not be lumped together with the overall primary home market - which is, for the most part, in the suburbs and outskirts of cities.

In addition, pockets of those 'second home' areas of New York City (areas like the Berkshires, Catskills, Poconos) that have inherent attributes (read: natural as opposed to man-made -i.e.; a casino) might, in fact, hold their own in a declining real estate market compared to other areas quite close by -- and even within the same county - due to 1. their natural outdoor recreation such as rivers and lakes, 2. proximity to the city under two hours, 3. declining prices and what the artcicle in the Wall Street Journal below goes into...4. 'The New American Gentry'...

TR
Narrowsburg, NY

At:

http://www.realestatejournal.com/secondhomes/20080123-dougherty.html

http://online.wsj.com/article/SB120069319738001353.html?mod=googlenews_wsj

The New American Gentry
Moves Out Into the Country
{Wall Street Journal}

By Conor Dougherty
=============================

[GNN]

TR - Thanks for posting the WSJ article. There's no denying what has happened over the past few years, but except for a quick reference to retiring baby boomers, the article does not really address what has been underpinning these events and, more importantly, it does not say that it is sustainable. Is this transformation being funded by second homes being purchased with easy money ? Are retirees funding their purchases by selling first homes at inflated prices ? I can't help but wonder what people were thinking in late 1929 or even 1999 before the bottom fell out of the stock market. I only imagine that they thought the good times would roll forever. History repeatedly shows that all hot markets need to correct, form a base (usually well below the peak) and then return to growth and prosperity. Fortunately, history also shows that markets do come back....for investors who are both patient and wise. But hey, discussions like this is what makes markets, right ? Only time will tell who's right. Me, I'm waiting for some balance to be restored. It's true that this day may or may not come. But we're talking about purchasing a second home. Not exactly an absolute requirement so I can afford to be patient and perhaps wrong.

[JM]

"But James W. Hughes, who has tracked the market for homes around New York City through cycles of boom and bust, said he expected it to be worse than — maybe twice as bad as — the fallout from the “real estate bubble” of the 1980s."

http://www.nytimes.com/2008/02/03/nyregion/03property.html?ref=nyregion

[TR]

{GNN}

"...Is this transformation being funded by second homes being purchased with easy money ? Are retirees funding their purchases by selling first homes at inflated prices?"
==============================

A good question.

Take a look at that online map from WSJ and you'll see that Sullivan County is part of the Dividend/Interest/Rent group.

For the most part, most of my sales in 2007 were to customers *over 55 years old* - either retrired, ready to retire in a few years or in semi-retirment looking for a 'part-time' home in an area that has small town charm - has cultural activities - i.e.; theatre, opera, the arts, etc. and affords recreation such as the river or lakes but also close to hospitals, et al such as Honesdale.

That runs counter to what Dave has posted is his core customer group - and those would be urbanites under thirtyfortysomething who have been priced out of city prices for the past five years.

TR

[David Knudsen]

This sure turned in to a sturm and drang apocalyptic thread. I think the "cash out on the equity in your primary home to buy a second home" trend played itself out about a year ago. Those buyers, who were often all-cash or high cash, certainly had an impact because they could pay more than appraised value for a house. But pretty much everyone I'm seeing lately is a standard financing buyer with 10% or 20% down.

What most people who foresee an impending collapse of the market are missing one thing — inventory here is still very limited, at least of houses with the most attractive home or setting features my clients tend to be looking for. This is a very different market than, say, Florida, where there are countless cookie cutter condos competing for limited buyers, or suburban tract developments with similar 'interchangeable' houses. New York area real estate, while not immune to macro factors, is much more nuanced. I expect there will be far greater variability in the 'downturn' throughout the NY region, than around Orlando, Miami, Phoenix or Las Vegas. I expect some areas will take a big hit, like suburbs in the 1+ hour commute to Manhattan circle, or with inconvenient transportation or marginal schools, while some affordable close-in areas, like attractive residential sections of Queens, may even see price increases as buyers shun areas they may view as undeservedly high priced (Williamsburg, anyone?)

Here in Sullivan, we've already seen about a 15% drop in the median and average sales price since the peak in the 2nd quarter of 2007. The problem we're having in the market here right now is that while that message has come through loud and clear to buyers, it seems like sellers are still waiting for the carrier pigeon to arrive. It will just take time for sellers to understand that their houses aren't worth what they were a year ago. In the meantime, maybe I'll just close up the house (and shut off that water pump!), put a 'Gone Fishing' sign up on this website (Ok, Tony, I know, I don't fish. But it sounds better than 'Gone Napping') and head off to a Caribbean beach for a couple of months.