Rising Mortgage Rates to Squeeze Pricey Markets First

Posted: June 13, 2013 in Mortgage Information

Buying a home will remain a better deal than renting in every major U.S. housing market as long as mortgage rates remain below 5.2%, according to an analysis prepared by Trulia TRLA -0.65%, the online real-estate site.

This means that while rising interest rates will dent affordability, the recent increase in rates to more than 4% isn’t expected to choke off housing activity.

Mortgage rates rose to 4.15% last week, according to the Mortgage Bankers Association, up from 4.07% the week before and a low of 3.59% last month. Applications for refinancing rose by 5% last week but were 11% below where they were three weeks ago. Applications for home purchases also rose by 5% for the week and stood 14% above their year-earlier levels.

Mortgage rates tend to track yields on 10-year Treasury notes, which have jumped as anxious investors sell off Treasury securities amid signs that the Federal Reserve may begin to slow down the bond-buying program it launched last year. Bond yields rise as prices fall. On Wednesday, yields on the 10-year Treasury were near a 14-month high of 2.21%, up from a low of 1.62% at the beginning of May.

Trulia looked at specific U.S. markets to determine how high rates would have to move to make renting less expensive than owning. As one might expect, rising rates will have a bigger bite in more expensive housing markets. In San Jose, Calif., rates above 5.2% would make renting more affordable than owning, while the tipping point in San Francisco is 5.4% and in Honolulu, it is 5.8%.

For the rest of the country, rates would have to be significantly higher to make renting more affordable than owning. Rates would have to hit 6.8% for the cost of owning to exceed the costs of renting in New York and in Orange County, Calif., and 7.5% for Los Angeles and San Diego.

In many of the hard-hit cities of the industrial Midwest where homes are very cheap, rates would have to be significantly higher—above 17% in Akron, Ohio, and above 20% in Cleveland; Toledo, Ohio; and Gary, Ind. Rates would need to hit a whopping 35.8% in Detroit for owning to become more expensive than renting.

Nationally, Trulia concludes that buying would still be cheaper than renting as long as mortgage rates are below 10.5%, largely because prices have fallen so far after the housing bubble has burst while rents haven’t fallen nearly as much.

A question that’s harder to answer, of course, is what effect higher rates could have on borrower psychology. Rising rates make housing more expensive, regardless of the favorable buy-to-rent comparisons. A rule of thumb holds that every one percentage point increase in mortgage rates makes homes about 10% more expensive for buyers by increasing the monthly mortgage payment.

For example, the monthly mortgage payment on a $200,000 home rises by $56, or around 6%, with an interest rate of 3.9% versus an interest rate of 3.4% that was being advertised just one month ago. The bottom line is that higher rates could take some of the edge off of recent price increases.

Trulia’s buy-versus-rent analysis assumes that home buyers are taking out a 30-year fixed-rate loan with a 20% down payment; that buyers are staying in their home for seven years; and that they deduct their mortgage interest and property-tax payments at the 25% tax bracket. (More on the methodology is available at Trulia.)

The buy-versus-rent equation is only one way of gauging how rising rates will influence affordability, and it doesn’t necessarily mean that demand will stay strong simply because housing is still affordable. In recent years, home prices have fallen even though owning has already been more affordable than renting.


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