Rising Home Prices Cause Homebuyers To Rush To Riskier Mortgage
Home prices are heating up yet again, and that is sending more potential buyers looking for ways to afford a monthly mortgage payment.
The number of adjustable-rate mortgage originations jumped just over 40 percent from the first quarter of this year to the second, according to analysis by Inside Mortgage Finance. ARMs offer lower interest rates than fixed-rate loans, and today’s ARMs usually have a fixed period of at least five years. That means the rate can change after five years. Still ARMs are considered riskier than the classic 30-year fixed mortgage.
The average contract interest rate on 30-year-fixed mortgages with conforming balances was 4.11 percent last week, according to the Mortgage Bankers Association. Compare that with the rate on a five-year ARM, which was 3.38 percent. The rate on an adjustable-rate loan, by definition, will change after the fixed period, moving higher or lower, depending on the broader market rate.
ARM demand usually rises from the first quarter to the second quarter, because spring is the busiest season for homebuying, and it’s when families dominate the market, searching for bigger, higher-priced homes. Still, the jump in ARMs in the spring of 2016 was 15 percent compared with this year’s 40 percent jump. This makes the case that buyers this year are struggling with affordability and opting for a lower-rate product.
While mortgage rates remain very low, historically speaking, they have been inching up. The vast majority of homebuyers favored the safety of the 30-year-fixed rate mortgage since the housing crash, but weakening affordability is now changing that.
Home prices have been rising steadily for the past three years, and while it looked like the gains were flattening recently, they appear to be heating up again. Prices nationally jumped 6.9 percent in August compared with August of 2016, the biggest gain in three years. The annual gain in July was 6.7 percent, according to CoreLogic.
“One thing that’s helped to fuel demand, and certainly home price growth, as much as the lean inventory of for-sale homes is that mortgage rates have really cooperated,” said Frank Nothaft, chief economist at CoreLogic.
Home prices have been rising far faster than inflation, but Nothaft predicts the gains will actually ease next year, if, as he expects, mortgage rates rise. That will be the tipping point, he said, although others argue that tight supply of homes for sale, especially on the low end, will keep prices lofty despite higher mortgage rates.
Already, close to half of the nation’s top 50 housing markets are overvalued, in relation to income and employment growth.
“Prices are being driven up by very tight market conditions,” noted Matthew Pointon, property economist at Capital Economics. “On a per capita basis, the number of existing homes for sale is at a record low, and buyers are therefore having to up their offers to secure a home.”
Pointon said home prices should actually be rising by more than 10 percent, given the tight supply, but tight mortgage lending standards are restricting that growth.
“Cautious appraisals are preventing desperate buyers from bidding too much for a home, as are strict debt-to-income ratios,” he said.
While ARM loans are often blamed for the epic housing crash in the late 2000s, the current ARMs are nothing like those of the past. Products like negative amortization loans, which offered very low rates up front but then tacked that initial savings amount onto the loan itself, no longer exist.
Loans must now be fully documented and underwritten to the full length of the loan in order to make sure borrowers can pay even if the rate goes up. Lenders must also make it very clear to borrowers that their rate is only fixed for a certain term, and that it will likely go up after that term, given the current trajectory of rates overall. That, again, was not the case in the past.