Mortgage Rates Won't Derail Housing Recovery, Analysts Say

Rising mortgage interest rates, spiking the most since 1987 to nearly a two-year high in a new report Thursday, are raising worries of a slowdown in U.S. home sales and price growth. But many analysts say the bigger impact will be on the refinance market.

The average 30-year fixed-rate mortgage soared from 3.93% to 4.46% in the latest week, loan-backer Freddie Mac (FMCC) said (plus 0.8 point in fees), tied to views that the government may taper bond-buying this year if the economy keeps humming.

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A rush to buy while credit's still cheap pushed up pending home sales in May by 6.7% from April to the highest since late 2006, in National Association of Realtors data out Thursday. NAR also raised its 2013 median home-price forecast to $195,000, or more than 10% growth.

Where will rates be a year from now? According to some recent estimates, 30-year fixed mortgages will range from 4.5% and 5% over the next 12 months.

Rates have gone up lately on the expectation that the Federal Reserve will end its program of quantitative easing designed to keep interest rates low and bolster the economy.

Fed Chairman Ben Bernanke hinted June 19 that the U.S. would end quantitative easing next year, which sent homebuilding stocks sharply lower and led to a drop in mortgage applications as mortgage interest rates rose with bond yields.

However, some economists say the market overreacted, and that the impact of higher rates on housing is being overstated.

Jay Brinkmann, chief economist with the Mortgage Bankers Association, says rising rates alone aren't enough to really hurt home sales over the long run.

"Some people might decide to buy a smaller house in a different area, but you won't see a big decline based just on interest rates," he said.

In fact, the opposite might happen, at least over the near term.

"In the past, you would see a rise in homebuying activity with rate increases. People who are on the fence about buying a home get off the fence in a hurry when rates start to go up," Brinkmann said.

Builder KB Home (KBH) downplayed the potential impact of mortgage rates as it reported its second-quarter results Thursday, which beat estimates and included revenue up 73% from a year ago amid higher home prices and a net loss narrowed to 4 cents a share from 31.

"Despite the recent rise in rates, affordability is still at extraordinary levels, and demand is significantly outpacing supply in every market we serve," KB Home CEO Jeffrey Mezger said on a conference call with analysts Thursday.

Noting that KB Home indicated 4% mortgage rates were not having material effect on demand or sales, Sterne Agee analyst Jay McCanless wrote in a research note that the builder should see average closing prices up 17.5% this year instead of his prior view of 10.2%.

Builder Lennar (LEN) offered sentiments like Brinkmann's in a second-quarter conference call Tuesday.

Investors 'Off Guard'

Lennar CEO Stuart Miller conceded that mortgage rates "have moved from their unprecedented low point towards more normalized levels," and that the timing of Bernanke's comments "has caught the investor community off guard and shaken investor confidence in the overall housing recovery.

The comments came after Lennar crushed Q2 earnings forecasts. Its stock price rose only slightly on the news that, and shares are still well down from a six-year high of 44.40. set May 20. Lennar did rise nearly 4% Thursday as KB Home fell nearly 1%. Lennar, KB Home and other major builders such as Pulte Group (PHM), D.R. Horton (DHI) and Toll Bros. (TOL) sold off following Bernanke's comments last week. IBD's Building-Residential/Commercial group fell 9% over a four-session period ending June 24, deepening a slide begun about a month ago.

The drop came despite mostly positive news for builders, and Thursday saw a not quite 3% gain.

Tuesday the Commerce Department said new-home sales in May rose to a 476,000 annual rate, up 2.1% from April, topping forecasts.

Because of the U.S. housing market's recent strength, many economists downplay the impact rising mortgage rates will have on housing. They say a much bigger variable is whether the economy will continue its recovery, and whether jobless rates will continue to fall.

They also say the refinancing market is much more likely to take a hit from rising interest rates.

"The main effect of rising rates is that fewer people refinance because refinancing is a purely financial decision," said Jed Kolko, chief economist at homes site Trulia (TRLA).

A report Wednesday by the Mortgage Bankers Association confirms that higher mortgage rates are already having an impact on refis. Its index of refinance applications fell 5% in the week ended June 21 even as purchase applications rose 2%.

The impact on home sales is not as easy to gauge.

Keith Gumbinger, vice president of mortgage data publisher HSH Associates, reckons mortgage rates will settle between 4.5% and 5% a year from now. Even at 5%, rates will still be on the low side.

"Anything below 6% is historically favorable," Gumbinger said.

Higher rates go hand-in-hand with a strengthening economy, Kolko notes, and shouldn't have much effect on sales in that event.

"Even though higher rates make housing more expensive, as the economy strengthens people are in a better position to afford more houses," Kolko said.