Mortgage rates will continue to rise. They will probably be near 5 percent by this time next year, compared to the 3.5 percent average of the past 12 months. The rates will be even higher in 2015 and 2016. Certainly, rising rates are bad news for buyers and some potential homebuyers will be pushed out of the market. For example, the number of renter households that have sufficient income to buy a $177,000 home at a 3.5 percent mortgage rate is 17.8 million. The number drops to 14.9 million at a 5.0 percent mortgage rate, which is a decline in percentage terms of 16 percent.
| Mortgage Rate | 3.5% | 4.0% | 4.5% | 5.0% |
| Home Price | $177,000 | $177,000 | $177,000 | $177,000 |
| Needed Income | $36,000 | $38,400 | $40,800 | $43,200 |
| Renters with Higher Income than Above | 17.8 million | 16.9 million | 15.9 million | 14.9 million |
But there is one major compensating factor that can easily neutralize the negative impact of rising rates. As REALTORS® well know, there are many good potential buyers who have been denied a mortgage that in past normal years would have easily qualified. The comparison is with normal years and not the bubble years of no standards whatsoever. The Federal Reserve has also often commented about the excessively tight underwriting standards in today’s mortgage market. At the same time, banks have been reporting a strong profit growth from mortgage originations due to exceptionally low default rates on recently originated mortgages, particularly since 2010. Such well-performing recent mortgages should not be surprising since defaults do not happen in an environment with rising home prices. It appears then more loan originations, at least at the margin, will bring more profits for the lenders and correspondingly bring more buyers out into the marketplace. My estimation says there would be an additional 15 to 20 percent more homebuyers who qualify by returning to normal underwriting standards from the current very tight conditions. The table below shows the average credit score of those who obtained mortgage approvals in recent years. The credit scores are much higher now than in past normal times. So, for example, someone with a credit score of 730 would have had no trouble obtaining a Fannie-backed mortgage in the past, but is currently getting denied today.
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On June 3, 2013, in Economist Commentaries, by Lawrence Yun, Chief Economist
