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Mortgage Rate Spike finally hits housing

Mortgage rate spike finally hits housing

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Published: Friday, 9 Aug 2013 | 11:26 AM ET

By: | CNBC Real Estate Reporter

Alberto Pomares | E+ | Getty Images

A sharp jump in mortgage rates from May to June are now beginning to weigh on the housing recovery. The two-month delay can be attributed to several factors—first and foremost that most potential home buyers lock in mortgage rates early, and sale closings can take up to two months to be finalized.

Second, there may also have been a surge in homebuying because of the rise, as those on the fence suddenly jumped in, fearing rates would continue going up and they would be priced out of the market. Those factors have now expired.

“We saw an increasing number of comments suggesting the sharp rise in mortgage rates has led to a pause in demand, with many agents saying the initial urgency they saw from buyers as rates moved higher has subsided and now buyers are stepping back to re-evaluate their options,” said analysts at Credit Suisse in their monthly survey of real estate agents. They noted a drop in buyer traffic in July, the first time since last December that it didn’t exceed expectations.

(Read more: Map: Tracking the US real estate recovery)

Home builders to weather rising rates?

Friday, 9 Aug 2013 | 1:19 PM ET

Mortgage applications to buy a new home jumped 14 percent in July, reports CNBC’s Diana Olick.

While buyers may be pausing, however, their optimism is not. Americans are increasingly hopeful about housing’s return. Sixty-two percent believe mortgage rates will go up over the next year, according to a new Fannie Mae survey, but 74 percent also say it is now a good time to buy a house, an increase in both from June.

(Read more: What you need to know if Fannie and Freddie go)

“Consumers have taken the interest rate rise in stride. Expectations for continued improvement in housing persist, and sentiment toward the current buying and selling environment is back on track from its dip last month,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “These results are consistent with our own analysis of previous housing cycles, which finds that interest rates and home prices are not strongly correlated.”

(Read more: Taking your calls now: Obama sells housing agenda via Zillow)

Another survey from home builder PulteGroup found 43 percent of move-up buyers indicating they are planning to buy a new home within the next five years, with 76 percent saying they believe they can sell their current home within the next two years for enough to move up. Pulte targets the move-up buyer.

Mortgage applications to purchase a newly built home rose 14 percent month to month, according to the Mortgage Bankers Association, but new home buyers may be less sensitive to rates, as builders can buy down mortgage rates as part of the deal.

It all prompts the question: With rates still historically low, does a 1 percentage point jump in rates really matter?

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“It absolutely matters,” said Craig Strent, CEO of Maryland-based Apex Home Loans. It does put people that are on the fringes that were just on the edge of qualification—it does kick them out from qualifying. For those that already did qualify, it’s psychological. All of a sudden that house that was going to cost you X, is now costing you another hundred dollars a month in mortgage payments and that does make a difference.”

There is also the question of home prices, which continue to rise because of a severe lack of homes for sale. This varies market-to-market, but is especially severe in formerly distressed markets that were targeted by investors.

“We see many threats to the housing recovery,” said Jaret Seiberg of Guggenheim Partners. “Rising rates will make homes less affordable. We also are concerned that investors have artificially stabilized some markets and driven prices up beyond what consumers can afford at today’s higher interest rates.”

By CNBC’s Diana Olick. Follow her on Twitter @Diana_Olick.

The future of Home Mortgages in the US

By Robert Pozen

Have you heard of the two terms –“risk retention” and “qualified residential mortgages”? Federal regulators are reportedly close to adopting rules defining these two terms, which will largely determine the future shape of the home mortgage market.

Here is the background. The Dodd-Frank Act tried to stop mortgage lenders from issuing mortgages and then immediately selling them to a large financial institution. That institution would put together a pool of home mortgages and sell securities based on the cash flows from the pool. Before the Dodd-Frank Act, because the issuers of many home mortgages immediately sold them, the issuers had little incentive to do a good job of checking carefully whether the borrowers would be able to pay off these mortgages. In other words, these issuers had “no skin in the game.”

In response, the Dodd-Frank Act generally required mortgage lenders to retain some risk in the mortgages they sold. In specific, these lenders were required to retain 5% of the economic risk if they sold mortgages that later defaulted. At the same time, Congress was concerned that such a requirement would lower the volume of new home mortgages. So, Dodd-Frank established several broad exemptions to the risk retention requirement for mortgages that Congress believed were relatively safe.

In the future, the home mortgage market will be dominated by mortgages covered by these exemptions. Almost every firm will prefer to originate and sell these exempt mortgages, rather than retain some of the risk that non-exempt mortgages will later default.

A look at risk

Let’s review the three main types of home mortgages exempt from the risk retention requirement and whether they seem justified. In this regard, studies show that low down payments are by far the best predictor of mortgage defaults.

First, Congress exempted from the risk retention requirement all mortgages insured by the Federal Housing Administration (FHA), which currently accounts for over 40% of the new mortgages in the US. These mortgages are issued by private lenders and then insured by the FHA if they meet certain criteria. But the FHA insures mortgages where the borrower makes a down payment of only 3.5% of the home’s value. So the FHA is insuring 100% of a mortgage where the lender retains no risk and the borrower has a very low down payment. For these and other reasons, the default rate on FHA-insured mortgages has been rising and the FHA is now in serious financial trouble.

Second, Congress exempted from the risk retention requirement all home mortgages sold by private lenders to Fannie Mae or Freddie Mac. These two large institutions went bankrupt during the financial crisis and were effectively taken over by the federal government. Yet both institutions currently buy over 40% of new home mortgages from private lenders and then effectively guarantee such mortgages against default. Although Fannie Mae and Freddie Mac have stricter standards than the FHA, they both will buy home mortgages where the borrower makes a down payment of only 10% of a home’s value. Again, the federal government is not protected from loss by either risk retention by the lender or substantial down payments by the borrowers.

Third, Congress gave the regulators express authority to exempt from the risk retention requirement “qualified residential mortgages” or QRMs. In my view, the criteria for QRMs will be followed by most private lenders for most homes mortgages not insured or backed by the federal government. If a lender follows these criteria and quickly sells the mortgage, the lender will not have to retain any risk of the mortgage defaulting. Most importantly, federal regulators proposed in 2011 that QRMs have a down payment of at least 20% of a home’s value. But this proposal was met by a barrage of criticisms that a 20% down payment would unduly slow down the mortgage market and undermine the goal of home ownership, so the regulators are reportedly ready to adopt a down payment standard of 10% or even 5% for a QRM.

In fact, most private lenders in Canada insist on a 20% down payment for home mortgages. And the Canadian housing market is booming–without a tax deduction for interest on home mortgages. Indeed, the rate of home ownership in Canada is higher than that rate in the US.

Down payments are key

In short, Congress was right to require mortgage lenders to retain 5% of the default risk in the mortgages they sell. This requirement creates the incentive for these lenders to check carefully on the ability of borrowers to pay off their mortgages. If we are going to waive this risk retention requirement for a broad array of home mortgages, we should make sure that the borrowers make a relatively large down payment. A large down payment by the borrower is the best way to reduce mortgage defaults without a risk retention requirement for the lender.

Pozen is a senior fellow in Economic Studies at the Brookings Institution and a lecturer at Harvard Business School.


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