Will rising mortgage rates spur home sales?

December 10, 2010: 11:13 AM ET

Historically low mortgage rates didn't encourage new home sales, but rising rates could finally push home-buying fence-sitters into the market.

mortgage ratesRates this week surged to a six-month high after President Barack Obama and congressional Republicans agreed to extend tax cuts for two years, including cuts for the wealthy. Though the deal is still being debated in Washington, financial markets interpreted the development as likely to accelerate the economic recovery but also swell the budget deficit. Though the yield on the benchmark 10-year bond has retreated some, it has still increased 21 basis points this week.

Because yields on Treasuries, especially the 10-year bond, largely influence mortgage rates, borrowing costs for mortgages have suddenly gone up. The average rate for a 30-year fix loan increased to 4.61% in the week ended Thursday from 4.46% the previous week, following a fourth week of increases, according to Freddie Mac (FMCC). The average 15-year rate rose to 3.96% from 3.81%. These rates are the highest they've been since June.

This follows a period of historically low mortgage rates. But even though borrowing costs for new home loans are cheap, they haven't exactly spurred the kind of home buying that one would expect. What's more, lower rates haven't spawned much refinancing, since many home owners are stuck holding property valued at less than what they owe on their mortgages. The latest Case Schiller Index reported that home prices nationwide declined 2% during the three months ending in September, after rising 2.4% during the previous quarter. According to Zillow, home prices have lost $1.7 trillion in value in the past year.

These are unprecedented economic times, and the allure of cheap credit doesn't seem to matter much -- at least not to consumers who are coping with an unemployment rate near 10%. Rising rates would seem to make housing matters even worse, but there's a glimmer of hope that the opposite will occur. Those buyers who have been eyeing new homes may finally pull the trigger once they realize that rates are heading north again. After all, borrowing is still cheap, and it's best to lock in rates today instead of waiting to see what happens tomorrow.

"Once people see this might actually be the bottom, they go for it." economist with Capital Economics Paul Dales tells Bloomberg. It's the same line of thinking that keeps retail investors from jumping into stocks at the bottom of the market -- it's only after they've seen it start to rebound that they get back in.

If indeed the latest rise in mortgage rates spurs more buying, this would be an ironic turn of events for U.S. Federal Reserve Chairman Ben Bernanke. Last month, the Fed announced plans to begin buying up hundreds of billions of dollars in U.S. Treasuries -- a rare and perhaps last-ditch move intended to keep yields on Treasuries low, helping give the economy a needed jolt from the slow recovery through cheap credit.

It remains to be seen how homebuyers will interpret the rising rates -- they will almost certainly slow refinancings since many mortgage holders will determine it's no longer worth it. Some might even want to wait for home prices to drop further, as some real-estate experts expected prices nationally to decline between 5% to 7%  in 2011 with most of the drop occurring during the first half of the year.

In the grand scheme of things, whichever direction Treasury yields and mortgage rates go might not even matter -- that's if the Fed's end objective ends up giving the economy a boost.

Also on Fortune.com:

What's hot for 2011: Mortgage-backed securities?

3 reasons why the mortgage tax break isn't a break

US Dollar rises: Thanks a bunch Europe!

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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