If you're in the market for a home, you're probably feeling pretty calm: Prices are falling, interest rates are low, and there are few other buyers to compete with. You can probably just hang out for awhile and wait for prices to fall some more.
But how long will the buyer's market last? Conventional wisdom holds that prices will fall another 5 to 10 percent, most likely bottoming out sometime in 2011. As the housing market stabilizes, sales will slowly pick up, while the huge backlog of foreclosed and bank-owned homes gets worked off. In healthier markets—like many in the Midwest, where there was never much of a bubble to start with—the housing market might even start to feel normal again in 2011 or 2012.
That outlook is based on the premise that interest rates will stay low, which has seemed likely because the Federal Reserve is pulling all the levers it can to do exactly that. But now something surprising is happening: Long-term rates are actually going up, in defiance of the Fed's actions. Data from federal mortgage agency Freddie Mac shows that 30-year mortgage rates reached a once-unthinkable low of 4.17 percent in early November, shortly after the Fed launched QE2, its second quantitative easing program. That's how the script was supposed to play out. The Fed's plan to purchase $600 billion in Treasury securities through the middle of next year will intensify demand for Treasuries, which in theory should drive rates down on everything linked to them, including mortgages. By the Fed's reasoning, that ought to make homes more affordable, get buyers off the sidelines, and put money into the pockets of homeowners able to refinance.
But suddenly, interest rates aren't cooperating. From that low point in early November, rates have risen several weeks in a row, with 30-year mortgage rates now at about 4.6 percent. That's still extremely low, but economists are now asking if rates are finally beginning an upward climb that could be permanent—and not because of the Fed.
[See what QE2 has done for you.]
The recent tax deal negotiated by the White House and Congressional Republicans includes a variety of tax cuts and spending measures that go a lot further than seemed likely when the Fed started its latest easing program. That's driving interest rates up, for two reasons. One, a surprisingly large fiscal stimulus plan makes the Fed's actions less necessary, so the Fed could curtail its easing program earlier than expected. And by adding nearly $900 billion to the national debt, the tax deal creates a bit more uncertainty about Uncle Sam's ability to pay off its debt. Higher risk means that investors demand a higher interest rate. And higher rates on Treasuries typically mean higher rates on mortgages, too.
Rising mortgage rates will scare off some buyers, such as bottom fishers or those who can only marginally afford to buy. But they could motivate others who might feel a newfound sense of urgency to lock in rates that are still remarkably low. "Higher mortgage rates could paradoxically give housing a temporary boost by pushing buyers off the fence," Moody's Analytics advised in a recent commentary on the tax deal. Interest rates, in fact, can surge with little warning, sending unhurried buyers into a scramble to find the right property and lock in rates.
A few tidbits of data might even suggest that we're near the beginning of a recovery in the housing market. Applications for new mortgages have been rising. Builders have been increasing their production of new homes. A measure of homebuilder confidence has been drifting upward. And economic news in general is becoming more positive. The stock markets survived the Irish debt crisis and recently hit a high for the year. Corporate profits are strong, and companies may begin hiring again if CEOs start to believe that the recovery is deeply rooted. Once consumers start to feel more secure in their jobs, spending on homes and many other things ought to pick up.
The overall housing market remains depressed, with activity still far below the boom levels of 2006. And some markets remain glutted with overbuilt developments and foreclosures. But recoveries usually start with tiny, even imperceptible, improvements. And they don't always come from the same direction that policymakers expect.