Concerns Rise With Mortgage Rates

Kerry and Troy Sincox spent the last five months on a priority list for new condominiums in Irvine’s Quail Hill development, but took a pass each time a new phase of the project came on the market.

Mortgage rates, they figured, were bound to keep dropping -- so why rush to buy?

Now the couple are anxiously awaiting the Aug. 16 opening of the development’s next phase to finally nab the $370,000 two-bedroom condo they want. But because mortgage rates have jumped since mid-June, many of the extras the Sincoxes had dreamed about probably are beyond their reach, said Kerry, 29.

“My dad kept telling us to wait, wait, wait, and now we’re looking at something like $100 more in payments” per month, she said, leafing through a glossy pamphlet of cabinet and flooring options. “I guess the Corian countertops are out.”

For a nation that since mid-2000 has grown accustomed to home loan rates moving in just one direction -- down, with a bullet -- the last seven weeks have been jolting.

Driven by a surge in government bond yields rooted in the sense that the U.S. economy is on the upswing, mortgage rates have rebounded from generational lows in mid-June to their highest levels since last summer.

The turnabout has triggered widespread anxiety not just for its effect on would-be home buyers, but for the broader potential fallout on pumped-up housing prices and on Americans’ increasing reliance on home equity to bolster their finances and fuel spending.

Already, rising mortgage rates have begun to choke off the refinancing boom of the last few years that has collectively saved consumers billions of dollars on their monthly payments and provided a critical prop for an otherwise anemic economy.

All of this is of particular concern in Southern California, where the housing market has been roaring since 2000 and mortgage refinancing has become almost a hobby for many homeowners.

Marty Rodriguez, a Century 21 agent in Glendora, said her first sign that rates were affecting demand came last week, when a $735,000 home she had listed suddenly fell out of escrow.

“Basically, the buyer decided he could only afford $700,000 now,” said Rodriguez, who has sold real estate in the San Gabriel Valley for 26 years. “It was bound to happen eventually. And I expect to see a lot more of it in the weeks to come.”

In Beverly Hills, a four-story, four-unit condo building under construction between Olympic and Wilshire boulevards has drawn less interest than anticipated, said Natasha Byrd, a real estate agent specializing in luxury condos in that area.

“I’m surprised they haven’t already sold,” she said. At $700,000 each for the 2,000-square-foot units, “the price is good, and the interest rate is still very good even if it has gone up. But this [segment] is moving slower than others,” Byrd said of the higher-end market.

Yet even as rising mortgage rates force some buyers to pull back, others, such as the Sincoxes, are scrambling to buy before higher rates price them out.

“We’ve had people waiting for mortgage rates to hit 50-year lows

Some national data last week confirmed that trend. The Mortgage Bankers Assn. said its index of loan applications to fund home purchases rose from the previous week to just under the record high set in late May, even as lending giant Freddie Mac said the average rate on 30-year conventional mortgages hit 6.34%, up from 6.14% a week earlier. The rate bottomed at a four-decade low of 5.21% in mid-June.

But after the fence-sitters have jumped, the question is whether higher mortgage rates will mean that housing demand faces an extended drought that could cause home prices to wither. For Southern Californians who remember the crash in home values in the early-1990s, the prospect of a rerun is chilling.

Back then, a deep recession, wildfires, the L.A. riots and, finally, the Northridge earthquake combined to push the median sales price of an existing single-family home in the Southland from a peak of $194,000 in the second quarter of 1991 to $160,000 in the first quarter of 1996 -- a 17% decline, according to DataQuick Information Systems. In L.A. County alone, prices plummeted 23%.

For someone who bought at the peak in 1991, it took eight years just to get back above water, not adjusting for inflation.

Since the first quarter of 2000, by contrast, the median sales price in the region has soared 60% to a record $319,000 as of the second quarter.

Southland housing analysts acknowledge that lower mortgage rates in recent years have helped to power demand and inflate prices. But many say two factors argue against a sharp pullback in home values even as interest rates rise.

One is that the region’s economy is in better shape than it was in the early 1990s. Los Angeles County’s unemployment rate was 6.8% in July, compared with 9.8% in the spring of 1992, for example.

And if interest rates continue to advance because the U.S. economy as a whole is accelerating -- driving up demand for credit and thus the price of money -- gains in families’ incomes could at least partially offset the damage that higher rates do to housing affordability.

“If the economy is doing better and household income climbs, that’s going to add fuel to the housing market,” said Robert Kleinhenz, senior economist at the California Assn. of Realtors in L.A.

A second factor that could support Southland home prices is that supply has dwindled relative to demand.

In June, L.A. County had a 1.7-month supply of homes on the market, based on the historical average sales rate, Realtors data show. In Orange County the supply was 1.6 months, and in Riverside and San Bernardino counties, 1.5 months.

In the early 1990s, the supply in all four counties almost consistently exceeded 10 months.

A collapse in the rate of sales could quickly cause inventories to balloon, of course. But even some analysts who are less sanguine about the housing market than many Realtors say the supply issue should forestall a dive in Southland home prices -- barring a sudden downturn in the economy that causes forced selling by desperate owners.

“I’d be very, very surprised if you saw the price declines you saw in the early 1990s” in Southern California, said Mark Zandi, co-founder of West Chester, Pa.-based forecasting firm Economy.com. Still, he warned: “I can see a few years of no price growth ahead.”

For the economy overall, a question that looms large is how much consumer spending could be restrained by the end of the mortgage refinancing binge.

Mortgage firm Freddie Mac estimates that refinancings cut consumers’ mortgage payments by $10 billion in 2002 alone. Although that isn’t a huge sum in an $11-trillion economy, the accumulated effect of falling loan rates since 2000 has been much more substantial, in part because many Americans pulled money out of their homes when refinancing -- turning equity into cash with a bigger loan at a lower rate.

That strategy has been a boon to Ariadne Shaffer and her husband, Costa Singer. Three years ago, they took their life savings of $4,000 and bought an inexpensive “fixer” home in L.A.’s Echo Park neighborhood. At the end of the deal, they had $10 left in their checking account to hold them until the next payday, Shaffer said.

Yet a year later they were able to refinance at a lower rate and pull $60,000 in equity out of the house, thanks to rising prices. That cash was used partly to fix up their home and partly to buy an investment property that has since been sold.

Today, their monthly mortgage payment of $1,210 is just $33 more than it was in 2000, but their net worth has vastly improved: They paid off their credit cards, cars and student loans, and they have about $10,000 in the bank, the couple said.

“It was completely a gift from falling interest rates,” Shaffer said.

But that game is ending. Mortgage applications for refinancings have plunged 59% since late May, according to the Mortgage Bankers Assn.

Losing the refinancing windfall could reduce real economic growth by almost a full percentage point in 2004 because of lower consumer spending, brokerage Goldman Sachs & Co. estimates. That would be a noticeable drag on an economy expected to grow 3% to 4% at best next year.

Other analysts are less concerned. A reviving economy, they note, stands to gain from other sectors -- such as business capital spending -- even as the refi benefit ebbs.

In any case, homeowners who have cut their mortgage payments since 2000 will continue to be better off than they would have been without the refi wave.

But even for refi veterans such as David Levinson of Los Angeles, the key is that home prices must stay up, keeping equity intact.

Part of Levinson’s long-term plan is that “if we hit some terrible financial straits down the road, I can always borrow against the house -- or sell it and move to South Dakota.”