Published January 13, 2015
The bond market is popping the dreams of home ownership for some Americans.
Home buyers who can only afford to buy homes with lower adjustable-rate mortgages (ARMs), those who can scrape into a house with more "exotic" loans with low teaser rates, and some investors contemplating second home purchases could be soon shut out as short-term rates rise, analysts said.
The ARM "was a creative and good product in the market that was utilized by a lot of savvy consumers and that's been great. But having said that, an ARM is no longer really an attractive option for the new home shopper, especially in this inverted yield curve," said Robert Foregger, chief strategy officer at EverBank, in Stowe, Vermont.
On Tuesday, two-year Treasury yields rose above 10-year yields, inverting the yield curve for the first time in five years. ARMs are pegged against the yields on shorter U.S. Treasury yields, and fixed-rate loans are set against longer Treasury yields.
This means that it costs more for banks and lenders to borrow short-term while earning less on longer-term loans they have on their books. If the curve inversion grows, banks and lenders will have to charge home buyers higher rates on ARMs than on fixed loans.
"As a borrower, you have nowhere to hide," said Greg McBride, financial analyst at Bankrate.com.
Higher ARMs rates will next year further crimp housing demand, which has shown signs of fatigue in recent months.
On Thursday, the National Association of Realtors reported that U.S. existing home sales fell 1.7 percent in November from October to an annualized rate of 6.97 million units, its lowest level since March.
The gap between fixed- and adjustable-mortgage rates has been narrowing since June 2004 in line with the shrinking yields between short- and long-dated debt during the Federal Reserve's rate-raising campaign.
Interest rates on 5-year hybrid ARMs, one of the most popular, averaged 5.79 percent this week, up about 0.75 percentage point since the beginning of the year, according to Freddie Mac on Thursday.
Rates on 30-year fixed mortgages, which account for more than two-thirds of all U.S. mortgages outstanding, averaged 6.22 percent, up 0.50 percentage point at the start of the year, Freddie Mac said.
Interest rates on exotic loans like interest-only and negative amortization mortgages are much higher than a year ago. In the same case, they are barely lower than traditional and less risky 30-year fixed-rate mortgages, analysts said.
"Interest-only and option payment loans had been ways to afford homes in expensive markets," said Amy Crews Cutts, deputy chief economist at Freddie Mac. "Now even, these products will no longer be attractive. That will impact affordability."
ARMs have allowed more people, including risky borrowers with spotty credit histories, to buy homes for the first time.
Interest rates on ARMs had been much lower than traditional fixed-rate loans and they allowed home buyers to make smaller monthly payments than those on fixed-rate loans.
While ARMs have been instrumental in expanding home ownership, their rapid growth in recent years worried regulators because speculators have used the more exotic types of ARMs to buy and quickly sell properties, especially condominiums.
"I think people who were trying to get into investment properties and trying to flip them won't see those financial advantages with the short-term rates being higher than the long-term rates," said Bob Moulton, president of Americana Mortgage Group in Manhasset, New York.
Higher short-term borrowing costs will not cause a housing crash and push the United States into a recession, the doomsday scenario some analysts have feared. In fact, a curve inversion may be a good opportunity for current ARMs holders to lock in lower long-term fixed loans, industry experts said.
"It reinforces a soft-landing scenario," said Richard DeKaser, chief economist at National City Corp. in Cleveland.