Mortgage rates fell ... but so did home sales
By Holden Lewis • Bankrate.com

At the beginning of 2006, everyone expected mortgage rates to rise. And they did. And then -- surprisingly, even shockingly -- they fell, along with house prices.

The average rate on a 30-year fixed was 6.27 percent in the first week of the year. It fell a tenth of a percentage point through January, then began a long march upward, peaking at 6.93 percent at the end of June.

It was around that time lenders started warning that rapidly rising rates were causing home sales -- and, therefore, mortgage applications -- to fall. By summer, the number of unsold houses on the market was approaching 4 million, a 40-percent increase over the inventory a year earlier. Even with the supply of houses outstripping demand, the National Association of Realtors reported that house prices were still rising.

The Realtors' chief economist, David Lereah, had been singing for years about the sunny real estate outlook. In February, he came out with a book titled, "Why the Real Estate Boom Will Not Bust -- And How You Can Profit From It: How To Build Wealth in Today's Expanding Real Estate Market."

"What you may not know is that opportunities still abound in U.S. real estate markets," Lereah wrote on the book's first page. "And those opportunities will continue to exist throughout this decade and into the next. What we are seeing today is a phenomenon that takes place only once every other generation: a long-term expansion of the real estate market. And that is why you need to take advantage of this once-every-other-generation opportunity now."

But just four months after "Why the Real Estate Boom Will Not Bust" was published, Lereah confessed to spotting some dark clouds: "a clear pattern of slower home sales activity in many higher cost markets, which are more sensitive to rises in interest rates."

Conventional wisdom held that mortgage rates would have to reach 7.5 to 8 percent and stay there for a while to cool off the hot housing market. The average rate on a 30-year fixed hadn't even reached 7 percent (It hadn't reached 7 percent since April of 2002!), yet home sales were tumbling and the inventory of unsold houses on the market was rising.

While impatient sellers and real estate agents were chewing on that development, a number of federal regulatory agencies were cooking up plans to protect consumers from the excesses of "nontraditional" home loans -- interest-only and pay-option adjustable-rate mortgages. These loans had skyrocketed in popularity in two years, largely in response to rapidly climbing house values on the east and west coasts.

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