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Why higher mortgage rates will help the housing market

March 18, 2013: 10:57 AM ET

Borrowing is still relatively cheap, so more potential homeowners may dive into the market.

121106105149-mortgage-debt-blogFORTUNE – Mortgage interest rates have been rising on signs that the U.S. economy is improving. Last week, the 30-year fixed rate reached the highest level in more than six months, climbing to an average of 3.63%, compared with 3.52% the previous week and 3.92% a year earlier. The current rate is the highest it's been since the week of Aug. 23 when the 30-year fixed rate averaged 3.63%, according to Freddie Mac.

With economic prospects improving, rates could rise even higher this year. This increase could mathematically make buying a home more expensive, but it's unlikely to stall the housing recovery. To the contrary, higher rates could actually support it.

For the past few years, mortgage rates have sunk to new lows as the Federal Reserve continues to buy up hundreds of billions of dollars worth of bonds. The policy is meant to get everyone from investors to consumers to borrow and spend more. While it has driven many homeowners to refinance existing home loans, it hasn't spurred nearly as many mortgages for home purchases.  In 2012, refinances made up 71% of all mortgage originations, according to the Mortgage Bankers Association, a group that tracks mortgage rates and home loan trends.

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Home sales last year rebounded more than most ever thought. Even if mortgage rates edged higher, the recovery could last for a few reasons.

For one, those who've been eyeing to buy a home may finally pull the trigger once they realize that borrowing is still cheap and it would be wise to lock in today's mortgage rate rather than wait and see where rates could fall tomorrow or months from now, says Andrea Heuson, finance professor at the University of Miami. "It could bring serious purchases back to the market."

To be sure, the Great Recession has proven that mortgage rates have almost no influence over home prices. And so the sustainability of the housing recovery will depend more on factors such as jobs growth than the cost of taking out a home loan.

If anything, slightly higher rates could reflect that slightly more risky borrowers are being offered credit following years of tighter lending standards. And this could be a good thing, says Barney Hartman-Glaser, real estate finance professor at Duke University.

"Although important, rising interest rates alone are not enough to slow down the housing recovery," says Hartman-Glaser, adding that "my sense is that underwriting standards are getting easier to satisfy, and so we would expect rates to rise as slightly more risky borrowers are brought into the fold."

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However borrowers interpret higher rates, the increase ultimately reflects an improving economy. Which, in turn, is something that would support the housing recovery rather than stall it. Investors have increasingly turned to riskier investments since the start of the year. The stock market has reached new highs, making bonds look less attractive and therefore pushing mortgage rates higher.

Heuson adds the rise in mortgage rates coincides with growing demand for loans across U.S. businesses – a marked turnaround from the dark days of the financial crisis and subsequent economic recession. At the end of January, commercial and industrial loans stood at more than $1.5 trillion, up more than 12.5% from a year earlier. What's more, the current level is more than 75% above the low point of $870 billion in mid 2004, according to Federal Reserve statistics.

"From that perspective, the recent increase … bodes well for the future of the U.S. economy," Heuson says, adding that when businesses borrow more, that will typically boost the economy in all kinds of ways, from spurring jobs growth to raising consumer confidence.

And last but not least, it could encourage more home sales.

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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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