Mortgage-Rate Rise Undercut Housing Market, Study Says

By Lucia Mutikani

A rise in mortgage rates could explain much of the weakness in U.S. home resales and further increases in the cost of home loans could dampen the recovery, a Federal Reserve Bank of San Francisco economist said in a paper published on Monday. Senior economist John Krainer said other factors, including uncertainty about the economy's prospects and investors retreating because of high house prices, were also dragging down existing home sales.

"Changes in fundamentals such as rising mortgage rates can account for much of the sluggishness in existing home sales over the past year," Krainer said. Home resales have slowed sharply since the second half of 2013, declining in seven of the eight months through March. They%VIRTUAL-pullquote- "Further increases in future mortgage rates could dampen the recovery in existing home sales." %
peaked in July.

Mortgage rates started trending higher last May in anticipation of the Federal Reserve scaling back its monthly bond-purchasing program. The 30-year fixed rate increased by about a percentage point from last May, when it was 3.54 percent, to its most recent peak of 4.49 percent in September. It has since dropped to average about 4.34 percent in April.

"This drop-off in sales seems more pronounced in some markets where investors had previously been active, though these markets have been slowing for the past several years, even before mortgage rates began to rise," said Krainer.

Investors were the main drivers of the housing recovery. They bought properties, most of which were in foreclosure after their owners failed to keep up with mortgage repayments, and converted them into rentals. Home sales were also slowing even in more distressed markets, Krainer said, adding that evidence suggested investors might be pulling back because of rising housing valuations.

"Further increases in future mortgage rates could dampen the recovery in existing home sales," he said. But high mortgage rates are not the only culprit behind the housing slowdown. Housing starts, which Krainer said were significantly low for this stage of the recovery, suggested other factors were at play. "Prospective home buyers may have impaired access to credit, they may be under water on their mortgages or have low home equity, or they may simply be reluctant to make large spending decisions when economic prospects are still somewhat uncertain," Krainer said.

"As the moderate recovery continues and these factors begin to dissipate, all forms of housing market activity, including existing home sales, should post more solid growth."