Rate Hike's Housing Impact? Balance of Wages, Home Prices Is Key

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Let the next great rate debate begin.

The increase last week in the federal funds rate, and the possibility of more increases in 2016, have fueled speculation about whether Federal Reserve action will help or hurt the housing market.

It is likely that home prices will decline as a result of the recent increase, and that could hurt the sales market, goes the prevailing argument.

But some mortgage industry optimists see a prospect for greater momentum in sales.

Who will be right? The answer could turn on whose assumptions about the direction of prices and wages, and the balance between the two, are correct.

Currently, improvements in home values are being driven by the low cost of mortgage financing. Those movements did not take into account the likelihood that the Federal Open Market Committee would raise short-term interest rates, said Rodney Ramcharan, research director with the USC Lusk Center for Real Estate.

On the other hand, investors in the equity and bond markets in recent weeks had priced in the increase. This was seen in the increase in the cost of the 30-year fixed-rate mortgage in recent weeks.

"The cost of debt financing is going up, and prices need to adjust to reflect that and it not obvious because house prices tend to be sticky," Ramcharan said. "It might take some months for those prices to fully reflect the fact that the cost of debt has gone up."

To cover the increased borrowing costs, one of two things will have to happen. Either wages will have to increase as well so borrowers have enough money to pay the debt (and it is an open question on how fast wages will grow, he pointed out), or sellers are going to have to cut what they are willing to accept for their properties.

The mismatch right now will likely lead to fewer properties going on the market and fewer sales being completed for awhile.

Yet other observers believe the FOMC action will benefit the housing market.

Taking the opposite view from Ramcharan on the issues of price and wage increases is Mark Fleming, the chief economist of title services and risk solutions firm First American Financial Corp.

"This increase can actually be a good thing for the long-term health of the housing market," he said. "We are finally embarking on a path of rate normalization that will slow price appreciation and implies faster income growth, ending an era of leverage-assisted asset inflation, which is hampering affordability and undermining the housing market."

The Mortgage Bankers Association "has been projecting a rate increase all year, and we have factored rising mortgage rates into our 2016 mortgage finance forecast," said Mike Fratantoni, its chief economist. "Due to the strength of the economy, we still project 10% growth in the purchase market in 2016, despite gradually increasing rates."

And one mortgage originator believes that falling home prices are not such a bad thing for the market.

"I predict that the Fed rate hike will create a better environment for first-time homebuyers," said Nick Stamos, the chief executive of Sindeo in San Francisco.

"As rates increase, home prices will begin to fall, which means that there will be more inventory, providing buyers with the ability to find the right house, at the right price, financed by the right mortgage."

He added that first-time buyers are able to take advantage of down-payment assistance and low-down-payment mortgage programs, which help make home buying more attainable.

Fleming agreed, adding the impact of the increase on first-time buyers would be small in the short run.

"Our Real Estate Sentiment Index indicated that first-time homebuyers are the most likely to be impacted by rising rates, but that their home-buying decisions will likely be unaffected until mortgage rates surpass 5%."

The increase could also mean more credit is available to consumers, especially those who need nonqualified mortgage products, said Rick Sharga, executive vice president of Auction.com.

"There's virtually no nonagency lending, almost nothing outside of QM. Higher interest rates may allow for loans to be priced in a way that accommodates some degree of risk," he said.

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