|
|
|
|
Extra
Fed waves red flag at home buyers, owners
An eighth consecutive interest-rate increase arrives, along with subtle and not-so-subtle signals that it believes the real estate party is over.
By Bankrate.com
There is a saying on Wall Street that speaks to the powerful influence of Federal Reserve interest rate hikes. The expression is "Don't fight the Fed," and it reminds investors that periods of rising interest rates tend to be pretty ugly for the stock market. Thus far in 2005, the expression holds true.
But with an eighth quarter-point interest rate hike arriving today, another even larger contingent of the American public -- homeowners and home buyers -- should pay close attention to this mantra. (For more on the Fed move and the markets' reaction, see Market Dispatches.)
Sure, fixed mortgage rates remain below 6%, and the housing market is strong, as evidenced by record sales of new homes in March.
However, several trends among home buyers and new homeowners seem to defy where the Fed is going. Buyers increasingly rely on borrowed money because of smaller down payments. In the highest-priced housing markets, borrowers are turning to interest-only loans and short-term adjustable-rate mortgages in record numbers, ignoring the consequences of rising rates on monthly payments a few years from now. Also prevalent among homeowners is the notion that they can always sell at just the right time, or refinance to another, more appropriate, loan at a later date.
Related news and commentary on MSN Money
People are convinced the path to financial security is as simple as buying a home and letting it appreciate them into wealth. It is no coincidence that the volume of homes being purchased by investors or speculators has reached a fever pitch, and the word "flipping" is now a household phrase.
But don't fight the Fed -- and the Fed is beginning to drop subtle hints saying as much.
Here is what Fed Governor Susan Schmidt Bies said in an April 18 speech. "However, we are beginning to see signs that housing prices may be reaching a peak in some markets. An increasing share of new mortgages is being taken out by investors rather than by occupants of the property. Some borrowers are stretching to buy their new homes using adjustable-rate, interest-only mortgages. Not only will these households face higher monthly payments as interest rates rise, they are also not building equity in their homes as quickly as they would with a traditional amortizing mortgage."
Or consider these more direct comments by Fed Governor Donald Kohn in a speech delivered April 22. "By increasing the return to saving and by damping the upward momentum in housing prices, rising interest rates should induce an increase in the personal savings rate, and thereby lessen one of the significant spending imbalances we have noted."
| Federal funds rate changes since June 2004 | | Date | New rate | Old rate | Change (in basis points*) | | May 3, 2005 | 3 | 2.75 | 25 | | March 22, 2005 | 2.75 | 2.5 | 25 | | Feb. 2, 2005 | 2.5 | 2.25 | 25 | | Dec. 14, 2004 | 2.25 | 2 | 25 | | Nov. 10, 2004 | 2 | 1.75 | 25 | | Sept. 21, 2004 | 1.75 | 1.5 | 25 | | Aug. 10, 2004 | 1.5 | 1.25 | 25 | | June 30, 2004 | 1.25 | 1% | 25 |
|
* One basis point is 1 one hundredth of a percent. Source: Federal Reserve.
Later in the same speech, Kohn said " we should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly."
Kohn draws a connection between rising interest rates and the potential for a decline in home prices, a connection many home buyers in the hottest markets have not yet made.
Warning lights flashing
With concerns about inflation, slower economic growth, an overheated housing market, debt-burdened consumers and a dreadfully low household savings rate, each quarter-point interest rate hike is more significant than the one before.
Continued Fed interest rate increases are like watching a weightlifter as weight is continually added to the bar. It isn't interesting when it starts, but as more weight is piled on, you wonder what will happen next. At what point do the knees start to buckle?
At what point will borrowers be tripped up by sharply higher payments on their adjustable-rate mortgages? What will happen with home prices, and how might this be altered if the Fed moves to a more-aggressive half-point increment at a later meeting?
The Fed has made clear an intention to continue raising interest rates beyond May 3. Now is the time for borrowers to heed the warnings of higher interest rates and the resulting consequences. After all, don't fight the Fed.
--Greg McBride
|
|
|
|
