The economy continues to expand, so builders are now wondering if the Fed will raise rates, causing mortgage rates to rise. Interestingly, we conducted a sensitivity analysis and found that builders of higher-priced homes are far more vulnerable to rising rates than entry-level builders.

While entry-level buyers are highly impacted by mortgage-rate changes, we found that high-priced home builders are even more exposed to mortgage-rate risk right now. We analyzed how a mortgage-rate increase from 5 percent to 9 percent would affect the number of households that would qualify for a $250,000 home as opposed to a $750,000 home. Here are our findings:

  • $250,000 Homes – Most of the United States’ 110 million households (60 million or 54 percent of total households) can qualify for a home priced at $250,000, assuming a 5 percent mortgage rate and 20 percent down payment. If rates rose to 9 percent, almost 22 million households (36 percent of those who originally qualified) would be “priced out of the market.”

  • $750,000 Homes – Slightly more than one-twelfth (9.7 million or 8.8 percent) of the United States’ households can qualify for a home priced at $750,000, assuming a 5 percent mortgage rate and 20  percent down payment. If rates rose to 9 percent, 5.9 million households (61 percent of those who originally qualified) would be “priced out of the market.”

    Therefore, the high-priced home builders would lose 61 percent of their potential buyers, while the low-priced home builders would lose only 36 percent. Fortunately, economists are projecting only slight rate-increases, as summarized below.

    Economic Growth: C-

    The U.S. economy grew at 4 percent during the 4th quarter of last year, slowing from 8.2 percent in the 3rd quarter. Though Real GDP growth has slowed, the economic situation in the U.S. is looking brighter. Payroll employment increased for the fifth straight month, and the unemployment rate has dipped to a two-year low: 5.6 percent. It appears that jobs are finally coming back in this previously “jobless” recovery.

    Leading Indicators: B

    The ECRI Weekly Leading Index’s 6-month growth rate continues to be high, indicating that the economic rebound should persist in the coming months.

    Mortgage Rates: A

    Fixed mortgage rates remained under 6 percent in January. However, recently released solid job growth numbers could spark the financial markets to move mortgage rates higher. The most recent Freddie Mac release shows mortgage rates holding steady at 5.66 percent.

    Historically low interest rates and strong price-appreciation in recent years have made housing markets in most areas of the U.S. extremely vulnerable to a spike in mortgage rates. However, economists are not anticipating an increase in mortgage rates in the near term. Here are some forecasts for 2004.

    The consensus theory about interest rates is that inflation should remain low because of Fed policies and employee productivity. Rates are expected to increase because economists expect the value of the dollar to decline, which will increase the price of goods we import from other countries, which will increase inflation slightly.

    Consumer Behavior: C+

    All consumer indicators moved upward last month, with consumer confidence reaching its highest level since November 2000. However, consumers remain tentative about the future of the job market.

    Existing-Home Market: B+

    Existing-home sales increased to 6.47 million annualized sales, as inventory fell to 4.3 months; a strong showing to finish off a record-setting year. Existing-homes sales in 2003 set a new record with 6.1 million sales.

    New-Home Market: B

    Annualized new-home sales slowed last month to 1.06 million, a strong finish to a fantastic year. In addition, the median new-home price fell to $197,600, representing 0 percent appreciation for the last 12 months. New-home sales in 2003 set a new record with 1.085 million sales.

    Housing Supply: C+

    Both housing permits and starts posted gains in December, showing continued strength in the housing market.

    John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis.


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