Mortgage rates rise as economy improves
By Holden Lewis • Bankrate.com

The benchmark 30-year fixed-rate mortgage rose 9 basis points to 6.44 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.34 discount and origination points. One year ago, the mortgage index was 6.30 percent.

The 15-year fixed-rate mortgage rose 13 basis points to 5.81 percent. The one-year adjustable-rate mortgage rose 7 basis points to 4.21 percent.

Rates rose as part of a generally favorable economic climate in which durable goods orders, consumer confidence and home sales posted good numbers. The most recent jobless claims report was OK -- nothing to cheer about, but not terrible.

Another factor could push long-term rates up: the federal budget deficit. The Congressional Budget Office predicts that the deficit will rise to $401 billion this fiscal year and $480 billion in the next. Theoretically, at least, the government competes with other borrowers when it runs huge budget deficits, and that causes rates to rise.

Just two months ago, the average 30-year mortgage rate was 5.31 percent. Now that it has risen so much in such a short time, three things have happened: Fewer people are buying houses, fewer people are refinancing their existing home loans, and adjustable-rate mortgages are becoming more and more popular.

The Mortgage Bankers Association says loan applications for home purchases declined 3.6 percent last week. Applications for loan refinancing went down 21.3 percent -- in just one week. For the first time since June 2002, fewer people applied to refinance their current loans than applied to finance home purchases.

And adjustable-rate mortgages, or ARMs, became even more popular: 24.4 percent of applications were for ARMs last week, according to the MBA. ARMs haven't been that popular since the week ending May 19, 2000 -- the same week that the average 30-year mortgage rate crested at 8.69 percent.

You would expect ARMs to make up one-quarter of mortgage applications when rates are high and are expected to fall. That was the situation last time ARMs were this popular. But right now, rates are low and have been rising, and are expected to keep rising.

"You would think a rational consumer would see interest rates start to rise, and with the economy beginning to show signs of recovery, and this huge looming federal deficit, why would you get an ARM?" says Leonard Zumpano, professor of real estate at the University of Alabama.

He has been mulling this question, and guesses that it's because ARM rates are so much lower than fixed rates. That makes ARMs difficult to pass up. The same theory is advanced by the Mortgage Bankers Association's economists.

They have a good case. This week, the average one-year ARM is 2.23 percentage points lower than the average 30-year fixed mortgage. Three months ago, the difference was 1.59 percentage points.

Zumpano says that borrowers who get one-year ARMs can feel confident they won't pay much more than 10 percent, even if rates skyrocket over the next few years. "I think more people are willing to take on that risk," he says. "Memories may be short. I remember when mortgage rates were 21 percent."

That was 1979 and 1980.

Surveys of homeowners show that one common reason for getting an ARM is to buy a more expensive house than the buyer could afford with a fixed-rate loan. That might be happening now. Perhaps buyers fell in love with houses back in May and June and July, then turned to ARMs so they could afford those houses after rates started to rise in late June.

The rapid rise in ARMs could herald problems with housing affordability. Even with today's much-lower interest rates, mortgage payments are higher now than they were three years ago.

In the second quarter of 2000, the median price for a resold home was $138,000, and the average rate on a 30-year mortgage was 8.34 percent.

In the second quarter of this year, the median home resale price was $168,900. This week, the average rate on a 30-year mortgage is 6.44 percent.

Assuming a 10-percent down payment, the homeowner who bought the median-priced house in the spring of 2000 had a smaller mortgage payment than the person who buys the median-priced house today -- even though rates are almost 2 percentage points lower.

The difference is small -- $14 a month -- but wages haven't risen much in the last three years, either. If rates continue to rise, as expected, home buyers will have two choices. First, they could adjust their aspirations downward and buy less expensive houses. That could slow housing price appreciation, or even reverse it in some areas. Second, they could continue to get ARMs and assume the very real risk that their monthly payments will rise a lot in the future.