Loan Modification

Interest rates increase, the FHA impact

By Peter G. Miller

It’s been an interesting few days on the mortgage front. Mortgage rates, according to Freddie Mac, have risen roughly half a percent during the past month or so. No less remarkable, it’s possible that rates will continue to rise.

The specifics look like this: Freddie Mac reports that the interest cost of a 30-year fixed-rate mortgage reached 4.61 percent for the week of December 9th.

“Interest rates for 30-year fixed mortgages are now almost a half percentage point higher than the record low set in mid-November,” says Frank Nothaft, Freddie Mac’s chief economist, Freddie Mac, “which for a $200,000 conventional loan amounts to $50 more in monthly payments.”

Get it? Rates are up half a percent but the actual cost increase is about $12.50 a week for a $200,000 loan.

In fact, today’s interest rates are ridiculously low. Yes, it’s true that in November mortgage rates dipped to 4.17 percent. But it’s also true that 4.17 percent is the lowest rate on record. If you have a choice between 4.17 percent and 4.61 percent then you surely want the lower rate. But compared to past rates which routinely have been 7 percent or more — and sometimes much more — today’s rates, as “high” as they are, are a bargain.

Interest Rate Increase

But, despite the bargain-basement rates we have seen all year, the rapid increase seen in the past month should be noted with some caution.

The housing market remains lousy. Home prices in the third quarter were 3.2 percent lower than a year ago according to the Federal Housing Finance Agency (FHFA). Unemployment remains high for the US at 9.8 percent in November. This figure from the Labor Department is good PR but less than the real unemployment level, the level you obtain when you include “marginally attached” workers.

The worry about the interest-rate spurt seen during the past few weeks is not that it represents a huge increase in costs but rather that marginal borrowers will be forced out of the market.

For instance, let’s look at FHA guidelines. Generally borrowers can use up to 31 percent of their pre-tax income for housing costs such as mortgage interest, principal, property taxes and property insurance. For a household that takes in $6,000 per month that means $1,860 can be set aside for housing expenses. If we figure $250 per month for property taxes and $100 per month for insurance that leaves $1,510 for principal and interest, an amount which will allow us to borrow $309,891 at 4.17 percent over 30 years. Raise the rate to 4.61 percent and we can only borrow $294,208 — more than $15,000 less buying power.

FHA loans will remain attractive if and when rates rise. They will still offer the benefits of little down, no prepayment penalty and no toxic terms. But the dull reality is that as rates rise — even a little — the number of qualified borrowers falls. And in this market that’s not something which is helpful.

Full post as published by FHA Mortgage Guide on December 13, 2010 (boomark / email).