Concerns over the economy going through a soft patch were diminished as third-quarter real GDP grew 3.7 percent. Although consumer confidence declined in October over the very tight presidential race and rising oil prices, consumer spending advanced a strong 4.6 percent in the third quarter. Adjustable and fixed mortgage rates both fell during the last month, however the spread between them narrowed as the fixed rate decreased more than the adjustable rate. Since May of this year, the spread between these two rates has narrowed by nearly 70 basis points, making adjustable-rate mortgages less appealing to borrowers who have the option of choosing a fixed-rate mortgage. We expect entry-level home buyers to find it harder to qualify for an adjustable-rate mortgage, while the high-end buyers will become more inclined to choose a fixed-rate mortgage.

Our grading system of the economy and the housing market is a “bell curve” model, with statistics at an all-time high receiving an “A,” statistics near the long-term average receiving a “C,” and the worst times ever receiving an “F.” In this grading system, it is OK to be a “C” student. Here is our current report card:

Economic Growth: C

Although there has been much talk about the economy undergoing a “soft patch,” the third-quarter real GDP reading came in at a healthy 3.7 percent, which is above the long-term target growth range of 3 percent to 3.5 percent. The economy added 132,000 jobs in September, bringing the 1-year growth rate to 1.6 percent. The first release of October job data was even more positive. This report adds more credence to the possibility that the Fed will raise interest rates during its upcoming meeting.

Leading Indicators: C

The leading indicators did not change significantly from the previous month. The leading indicators predict very modest (below average) economic growth.

Mortgage Rates: A

The one-year adjustable and fixed mortgage rates both fell in September to 3.96 percent and 5.64 percent, respectively, and continued driving home sales throughout most of the United States.

The fixed/adjustable-rate mortgage spread has been above its long-term average of 2 percent since July 2003. After peaking this year in May at 2.39 percent, the spread has narrowed by nearly 70 basis points since then, to 1.68 percent. The wider spread made an adjustable-rate mortgage a “no-brainer” choice for borrowers when financing their home purchases. This wider spread also made homes more affordable for many buyers who otherwise would not have been able to qualify for a standard mortgage.

With the Federal Reserve tightening its monetary policy, short-term interest rates should continue to rise, narrowing the spread between adjustable and fixed rates. This will decrease the incentive for borrowers to choose an adjustable-rate mortgage versus a fixed-rate mortgage. Even a small increase in rates may price out a noticeable amount of entry-level buyers out of the market.

Consumer Behavior: C+

Consumer confidence fell in October over worries about the economy, presidential elections and the escalating unrest in Iraq. Most measures remain near their long-term averages.

Existing-Home Market: B+

September sales of existing homes rose 3.1 percent from August to a 6.75 million annual sales rate in October. In September, the inventory of existing homes fell to 4.4 months from August’s revised 4.5 months. The low-interest-rate environment has helped increase the purchasing power of borrowers wanting to purchase a home.

New-Home Market: B+

The U.S. Commerce Department reported that September new-home sales rose 3.5 percent to a 1.205-million-unit annual rate, the third-highest pace recorded. September new-home sales rose in all U.S. regions except again in the West, where sales fell 0.8 percent. Sales climbed 6 percent in the Northeast, and were the strongest in the Midwest where they increased 12.3 percent. In the South, sales were up 2.7 percent.

Housing Supply: C

Although the total housing supply increased in September from August, housing starts actually decreased from 2,020,000 to 1,898,000.

What a difference a month makes. While we reported last month that the multifamily market was struggling, this month it showed signs of a recovery. The average vacancy rate fell for the second consecutive quarter, while rents rose 1 percent from the second quarter. These results are due to a stronger job 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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