What will happen when mortgage rates spike?

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Last week, the Federal Reserve announced that it would be winding down its $1.25 trillion effort to purchase mortgage-backed securities later this year -- ending a program that has been instrumental in driving mortgage rates to record lows, which helps make homes more affordable with lower monthly payments.

Gibran Nicholas, Chairman of the CMPS Institute explains how the end of that subsidy could impact the housing market: "Take out the Fed's subsidy, and mortgage rates are likely to drift back up by at least 1 percent. A 1 percentage point increase in mortgage rates -- from 5.25% to 6.25% -- would cost an extra $127 per month and $45,730 in interest over the life of a $200,000 30-year mortgage. This is exactly what could happen in 2010 once the Fed stops buying mortgage bonds."

Add in the potential for inflationary pressure that so many market prognosticators are forecasting, and 2010 and 2011 could be a real doozie for mortgage rates -- and the housing market at large, because higher monthly payment requirement will mean people will only be able to afford smaller mortgages.

Rising interest rates could also hurt President Obama's plan to modify mortgages. The vast majority of people who qualify for modifications are still waiting for action and by the time the bureaucratic mess gets a chance to look at their files, rates could be too high for a workout.

What's the solution? I'm not really sure that there is one. At some point rates will have to go up to head off inflation, and a lot of people will get left in the dust.
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