Buy That Home Before Mortgage Rates Go Up

July 2, 2003 -- — As most Americans know, thanks to low interest rates, there has not been a better time to buy or refinance a home in years. And Americans, not averse to a good deal, have been buying and refinancing in record numbers.

But, the question is, for how much longer?

Even though there are still concerns about the short-term health of the economy, in the long term, with the success of the war in Iraq and the passage of the president's tax-cut package, investor confidence appears to be on the upswing. That's good news for the stock markets but not such good news for the real-estate market.

In other words, if you are still thinking about buying or refinancing, you better get on it.

That's because many economists — such as Lawrence Yun, senior economist at the National Association of Realtors, and Celia Chen, director of housing economics at Economy.com — predict that when the Federal Reserve finally does raise interest rates in reaction to a growing economy, and when mortgage rates climb past the 6 percent mark, real estate will become less affordable, and the housing market will slide into stall.

Home shoppers may have less than a year to take advantage of home-buying opportunities before mortgage rates rise again. "We see mortgage rates rising once there are firm signs of an economic recovery," says Yun. "We see rates starting to move, albeit modestly, by late summer. Currently at 5.4 percent, mortgage rates could be up to 6 percent by the year's end."

Timing a Slowdown

For homeowners, that could mean that after three years of 6 percent and 7 percent home-price appreciation rates, home prices will likely return to a 4 percent-plus appreciation rate.

While history tells us that a drop in the housing market is inevitable following a real estate boom, the only question is how fast and how far the drop will be. Some economists predict it will happen quickly, in which case home values will suffer major declines. (Since the average appreciation rate is about 4 percent, if the figure falls below 4 percent, it's significant. If the price actually declines, it's disastrous.) In the International Monetary Fund's World Economic Outlook report published in April, for example, the housing bubble was cited as one of the many "threats" to the world economy in the next year.

While the potential dangers of a housing bubble are constantly being discussed and dissected, many economists believe that even if regional bubbles exist, on a national scale home values will continue to increase — just at a slower rate than in recent years. (There hasn't been a single year that prices have declined since the National Association of Realtors started collecting price data in 1968.)

Real estate buyers have become spoiled in the last few years. At 5.4 percent, mortgage rates haven't been this low in 40 years. Even a 6.5 percent mortgage rate is a bargain compared to, say, the early 1980s, when mortgage rates ranged between 11 percent and 17 percent.

As a result, millions of Americans have spent trillions of dollars on housing stocks over the last three years. In fact, the National Association of Realtors recently announced that despite the three-year real estate run, in the first quarter of 2003 yet another record was set for the number of existing home sales: 6.68 million. Once mortgage rates rise, demand will thaw, and when demand wanes, home values will drop. But a drop may not represent cause for concern.

"Home sales are happening at a torrid pace," Yun says. "Even if mortgage rates rise by 1 percent, sales will still be strong."

The End of an Era?

The real estate boom was also due in large part to the fact that many Americans sought new places to invest their money, following the collapse of tech stocks. Over the past three years, Americans who watched their 401(k)s evaporate and their investment portfolios drop in the double digits found safety in real estate, where home prices were appreciating at astonishing 6 percent-plus rates. If real estate begins to look less appealing as an investment and people begin to put their money elsewhere, it would contribute to an industry slowdown.

But the economic anxieties that helped along the housing market may be thawing out. The Conference Board's Consumer Confidence Index increased in both April and May, after a four-month decline. Consumers' short-term expectations improved, and the percentage of consumers anticipating an improvement in business conditions over the next six months increased. And when confidence is high, Americans may warm to riskier investments, further away from the home.

The larger issue isn't simply how a housing slowdown will affect individuals' properties, but what will the American economic recovery look like without the housing market — especially given the fact that real estate has been the nation's economic crutch during the last three years?

"Our outlook is that housing activity will slow, with the most significant weakening in 2004," says Economy.com's Chen.

"At the same time," Chen adds, "other facets of the economy, particularly business investment, will pick up steam, more than offsetting the slowing housing market. However, if the housing market slows more dramatically — perhaps if mortgage rates increase faster than expected, or if some of the more overheated housing markets collapse — then the housing market would place a significant drag on the economy."

For more, go to Forbes.com..