Mortgage Rates Spike. What Now?


You may have noticed: Mortgage rates are spiking. From a low of 3.34% earlier this year, the average 30-year mortgage now runs 3.81%. Most of that gain came in the last week.

What's going on? It's likely a combination of two things. Federal Reserve chairman Ben Bernanke hinted last week that the Fed may begin tapering its "quantitative easing" policies sooner than some imagined.There also seems to be a general sense that the economy is getting better. That pushes investors away from safe assets like mortgages and toward riskier ones like stocks.

The common reaction to rising mortgage rates is to wonder whether it will sting the housing market. Indeed, it may. But you have to keep perspective. Mortgage rates are rising from absurdly low rates. The "spike" of the last week brings interest rates back all the way to where they were less than a year ago. In context of the last 30 years, the rise is barely noticeable:

Source: Federal Reserve.

On a $200,000 loan, a 30-year mortgage at 3.3% (where rates were in January) costs $875 per month, while a 3.8% mortgage will set you back $931 per month.That's probably not going to price many buyers out of the market, especially if rising rates are associated with a stronger economy and jobs growth. The textbooks say higher mortgage rates are bad for the housing market, all else equal, but in reality, all else is never equal. The last rising interest rate cycle, from 2002 to 2006, was during the greatest housing bubble in history.

Besides, by most measures, homes are still pretty cheap. Take the National Association of Realtors' measure of housing affordability, an index of home prices and mortgages rates. It's still high:

Source: National Association of Realtors.

So, consider me skeptical of the idea that a 3.8% mortgage rate will hurt the housing market.

It is, however, likely to put a dent in both mortgage refinancing and mortgage REITs.

The Mortgage Bankers Association's Refinance Index fell 12% last week. Rising rates could push that gauge even lower, although higher home prices allow more homeowners to refinance and could be an offset. Industry leaders Wells Fargo and JPMorgan Chase both enjoyed big income from mortgage banking in 2012. Those days may soon be gone. As Fool banking analyst Matt Koppenheffer recently discussed, not only is refinance activity falling, but the margins banks earn on refi activity is also narrowing.

And pity the mortgage REITs. Annaly Capital and American Capital are down 13% and 19% in the last month, respectively. "The most advantageous environment for these kind of companies is when you're in a high-and-going-to-low interest rate environment," Koppenheffer mentioned this month. That ain't us. And it helps explain why these high-yield investments are getting smoked.

I'll finish with some perspective. Check out this 1980 newspaper article discussing the burdens of a 17% mortgage rate. It could be worse.

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Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase. and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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