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The downside of low mortgage rates

January 04, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Just before Christmas, two announcements seemed to herald a recovery in the housing market. However, just as with all the inflatable Santas cluttering lawns in December, the air might be out of the hopes for housing recovery before we get far into the new year.

On December 21, the National Association of Realtors (NAR) announced that existing home sales had risen in November -- up 4 percent over October's figure, and up 12.2 percent year-over-year.

The next day, Freddie Mac announced a new record low for 30-year mortgage rates - 3.91 percent.

On paper, this could make it appear that the housing recovery is shaping up as planned: lower interest rates create new housing demand, which fuels a recovery in sales and housing prices. However, a closer look at the numbers doesn't support that optimistic view.

A closer look at home sales

The NAR press release points out that existing home sales in November were at a 10-month high, up 4 percent from October, and up 12.2 percent over the prior November. All of this is true, but the numbers still don't add up to a picture of a robust recovery in housing. After all, consider these three other facts:

  1. While existing home sales have recovered in recent months, they are still below the level at which they started the year.
  2. The 12.2 percent year-over-year increase may be helped by the fact that last year's figures were recently revised downward by 14.6 percent.
  3. At $164,200, the median price for existing homes is down 3.5 percent from a year ago.

Housing sales plunged in 2007 and 2008, and since then have been in more of a holding pattern. While it is fortunate that the sharp decline has leveled off, it would still be premature to call this a recovery.

The question is, why has a recovery taken so long to materialize? After all, home prices are down, and current mortgage rates are at record lows. Basic economic theory says that lower costs should stimulate demand. Is the problem simply that people are still scared off by the housing slump?

Are current mortgage rates scaring off banks?

Another possibility is that it is bank executives, not prospective home buyers, who are scared off by the housing market. The reason might be those record low mortgage rates.

After all, signing up for a 30-year mortgage isn't just a commitment by the home buyer. It is also a commitment by the lender. At current mortgage rates, that means committing to 30 years of record low interest, at a rate below the long-term rate of inflation over the past 50 years.

That's hardly a compelling business proposition. At best, it means banks aren't marketing mortgages with their prior enthusiasm, and at worst, it means banks are making it more difficult for qualified buyers to get a mortgage. Either way, it helps explain why home sales have been slow to respond to lower mortgage rates.

Your responses to ‘The downside of low mortgage rates’

Showing 2 comments | Add your comment
Richard Barrington

13 January 2012 at 6:45 am

J: You are right that banks make money off the spread, but what is troubling for banks today is the mismatch between their short-term sources of funding and the long-term commitment to earning low rates on a mortgage. If interest rates rise, banks could see their cost of funds quickly rise past the sub-4% rates they've locked themselves into earning over then next 30 or so years.The timing mismatch is always a source of risk, but it is exacerbated when mortgage rates are at an all-time low.


12 January 2012 at 6:46 am

The rate banks offer for mortgages are (with some simplifying assumptions) a spread over their cost of funds. They care not a whit whether they fund themselves at 4% and you borrow at 6% or if they fund themselves at 1% and you borrow at 3%.

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