January 19, 2014

The Link Between House Prices And Earnings

Readers suggested a topic on interest rates. “Mortgage rates will be going up soon, and as everybody knows, when rates increase home prices increase too, so smart home buyers should buy now to lock in a low interest rate at an affordable purchase price before rates and prices go up.”

A reply, “Mortgage rates normally rise as the inflation rate rises. Inflation leads to a rise in wages and house prices will rise as wage inflation occurs. In this case we have a disconnect with the Mortgage rate artificially low and little sign of wage inflation, so I rather doubt house prices will rise, unless wages do. If wage inflation fails to occur house prices will drop, as people will be unable to support the higher cost of home ownership.”

One said, “Wages are going nowhere. The only thing that can drive prices higher at this point is artificially constrained supply and lower interest rates. The millenials had their future completely sold out from under them, and are awash in debt at graduation, with no job prospects that will allow them to pay it back. They were the foundation of the housing food chain, and this will become more apparent as the oldsters die off.”

Mortgage Solutions. “Leading economist Roger Bootle of Capital Economics, speaking at the Tenet Group conference in London, said that despite a prolonged period of low interest rates the current earnings to mortgage payments ratio was only slightly below historical averages. He warned rising interest rates would cause a spike in the number of borrowers unable to cope. ‘If you look at affordability, the percentage of a person’s income that they pay out on a mortgage has been comfortable at the long-term average and is currently just below. But it should be below given the base rate is at 0.5%, what do you think it will be like when there are normal rates of 5% or 6%? Mortgage rates will be 7% , 8% or 9% and it will look rather different, a lot of people would find themselves incapable of servicing their mortgages at that sort of level of interest rates.’”

“Bootle said the link between house prices and earnings had drifted but higher interest rates would see this return to normal levels. ‘This has important implications,’ he warned. ‘Somewhere in the future, not this year or even next year, but between four and five years’ time, we will have of two events. We are either going to have a housing market crash with big falls in house prices sustained over a long time to get this ratio back to normal.’”

“‘Or the government is going to preside over a period of higher inflation, including higher wage inflation, accompanied by a weaker exchange rate in order to bail the market out and restore this relationship without house prices falling. I think we will see one of those two things.’”

The Des Moines Register. “Iowa Bankers Mortgage Corp. President Dan Vessely and Fannie Mae Chief Economist Douglas Duncan both fear that one of the most under-appreciated consequences of the new qualified mortgage rules will be higher mortgage rates, especially for loans that almost meet the threshold. That’s because the rules also cap the combined points that mortgage originators and repurchasers may charge at 3 percent. Points are a kind of fee for them — often accepted from borrowers in exchange for a lower interest rate.”

“‘Banks are in the business of making money and if this regulatory change decreases the profitability on mortgages they have to recapture that someplace else,’ Duncan said. ‘It would not surprise me to see that result in higher interest rates.’”

“One way to make a borderline mortgage loan both compliant under the new rules an viable for the lender is to raise the interest rate, according to Vessely. ‘A definite result of this new rule will be higher interest rates in order to have certain loans meet the new qualified mortgage rule,’ he said. ‘Whether it’s an intended consequence or an unintended consequence, the rates are going higher.’”

From Miami Today. “‘Forgive me if I do not raise a toast to the start of a new phase of robust growth in the US economy that is here to stay: to a long-awaited period of actual recovery that will lift all boats with its rising tide of prosperity,’ University of Central Florida economist Sean Snaith wrote recently in his annual economic forecast.”

“‘I’ve seen this movie before and that is not what follows this current scene of economic data reports,’ he added. ‘I know the villain awaits us in 2014 and the uncertainty of the Affordable Care Act, Dodd-Frank regulatory reform, and what path the Fed will follow as it unexpectedly took its first step in its taper off of bond purchases in December are a cabal conspiring to suck out the wind that currently is providing the economy with its lift.’”

“Data shows that prices have risen significantly. It has sent a signal to builders that more inventory is needed as housing construction activity has increased. In the Miami-Fort Lauderdale-Pompano Beach metro area, housing starts are expected to rise in 2014 for the fifth consecutive year after bottoming out in 2009.”

“‘All these are indicators of a high grade housing market,’ Mr. Snaith wrote, ‘yet housing in Florida enters 2014 in a delicate condition as new regulations are set to kick in, interest rates are set to rise as the Fed has taken its first steps to tighten monetary policy, and the diminishing role of cash investors raises questions about the sturdiness of Florida’s housing recovery.’”

“He noted the role of investors is starting to wane, as evidenced by a declining level of cash transactions from a year ago. ‘These investors, unlike the flippers of the bubble era, are driven by portfolio concerns,’ he added. ‘Real estate prices have been rising in Florida over the past several years and this ironically makes housing in Florida a less attractive investment by reducing the expected return of housing. Higher sales prices reduce the return both by decreasing the rental yields and by reducing the size of capital gains when investors seek to sell the home.’”

“Meanwhile, the availability of mortgage financing is just a fraction of what it was prior to the housing collapse. The Mortgage Bankers Association’s Credit Availability Index dropped in November to 110.2. The index is benchmarked at 100 in March 2012. To get a sense of how much housing finance has dried up, if the index had been tracked in 2007, the association estimates that it would have stood at 800.”

“‘While [mortgage] standards in 2007 were clearly too lax,’ Mr. Snaith wrote, ‘current availability of mortgage financing is just 14% of what it was back then and is likely too tight to allow for a smooth transition from an investor-driven to a traditional buyer-driven housing recovery.’”

Bits Bucket for January 19, 2014

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