Minimal Impact from Higher Fed Rate July, 2004 By Jim Woodard For the first time in four years, on June 30th the Federal Reserve announced a hike in the federal funds rate from 1 percent to 1.25 percent. However, analysts say the rate boost will be mostly painless. Short-term rates will continue to linger near rock bottom levels, they predict; while long-term interest rates have remained relatively low even after adjusting upward in anticipation of the Fed's move and are expected to stay that way in the foreseeable future. Analysts explain that the bump up to a 1.25-percent Fed funds rate still will stimulate the economy. "It doesn't materially change the after-tax costs of mortgages," notes Bank of America chief economist Mickey Levy. "Households can still borrow at very favorable rates, businesses' cost of capital is still low, and the Fed is still pumping in money." It’s the “measured pace of future rate increases” that worries some analysts. This first small increase is a “soft landing” effort to keep the rate of inflation in check. Even though rates will inevitably continue to rise, historically low interest mortgages will be available to consumers for at least the next few months. * * * Alternative Types of Mortgages In the wake of rising mortgage interest rates, many borrowers are turning to alternative types of loans to either finance the purchase of a home or refinance an existing mortgage. The traditional 30-year, fixed-rate mortgage has long been the loan of choice for most borrowers. But rising interest rates can rapidly change the preferences of consumers. Now, adjustable-rate mortgages (ARMs) are becoming more popular, with initial rates substantially lower than fixed-rate loans. In recent weeks, about a third of new mortgage applications have been for ARMs. That reflects an increase of about 14 percent from a year ago. To save even more money spent on mortgage payments, an increasing number of borrowers are opting for an interest-only loan. Many rationalize that this type of mortgage will leave additional funds for strategic investments. Most interest-only loans are for a specified number of years. It then reverts to an amortized loan for the remainder of its term, requiring interest and principal payments. These loans usually carry a slightly higher interest rate than a conventional amortized mortgage. Also, keep in mind that while it’s an interest only loan, there is no lowering of the principal balance. The only equity that accrues in your home is from the value appreciation of the property. Many financial professionals believe this type of loan is best suited for affluent borrowers, especially those who have good reason to anticipate higher incomes in the future. They often caution against an interest-only loan for those who simply don’t have the income to support an amortized mortgage. Hybrid ARMs are also experiencing a growing popularity at this point. These loans offer a fixed-rate for several years – usually 5 to 7 years – then revert to an ARM. The interest rate is significantly lower that a 30-year fixed-rate loan, yet the borrower has assurance that the rate will not change for a period of years. Other mortgages available today include ARMs that can be converted to a fixed-rate loan. There are dozens of varieties of mortgage plans offered to consumers in today’s market. The challenge is to pick the one that meets your personal needs most precisely. “The myriad of financing products currently available has helped many people choose the loan that’s right for them,” said Doug Duncan, chief economist for the Mortgage Bankers Association. * * * Home Remodeling: a Booming Market Activity Home remodeling is a rapidly growing activity in today’s real estate market. Many families that need more space and amenities in their residence are opting to remodel and add rooms to their existing home rather than moving up to a new and larger home. Many owners feel it’s the most prudent step at this point, considering the super high price tags on today’s homes and the availability of low-rate mortgage funds to finance the project. Homeowners are also convinced that a carefully planned remodeling project will boost the market value of their property, possibly increasing it more than the remodeling cost. They often generate funds for the project by refinancing their existing mortgage with a new low-interest cash-out loan (using cash they receive beyond the payoff of their existing mortgage). “Continuing low interest rates, rising home values and strong home sales are definitely contributing to the remodeling fervor among home owners,” said Mike Weiss, chairman of National Association of Home Builder’s Remodelers’ Council. “In addition, the rebounding economy and rising consumer confidence are fueling substantial new interest in remodeling. “Those gains are apparent for every single component of remodeling activities, including calls for bids and amount of work committed for the next three months for both owner- and renter-occupied dwellings. There are also gains in overall project backlogs and appointments for proposals.” Among the most popular room additions in today’s remodeling projects are bedrooms, baths and laundry rooms. The modernizing of kitchens is also an important part of many projects. Another high priority item is additional space for a home office. An increasing number of people prefer to work from their residence, part-time or full-time. This way they don’t have to endure grueling commutes or spend hours away from their families. Also, hot-selling colorful office chairs, work tables and other innovative furnishings indicate the popularity of in-home offices, it was noted in a report from the National Association of Realtors. “We’re seeing more applications coming in from individuals who want to refinance their mortgage to benefit for the still-low interest rates, and at the same time generate cash to pay for a remodeling project,” said Michael Levy, president-CEO of Home Savings Mortgage, a multi-office mortgage banking firm based in Oxnard, California. * * * Limits Rising on VA Mortgages A new law that would boost the maximum Veterans Administration mortgage guarantee from $240,000 to $333,700 is working its way through Congress. It was recently passed by the House of Representatives. The objective of the new legislation is to keep the assistance available to veterans in line with higher property prices nationwide. “The value of their housing benefit should not vary depending on their local housing market, nor should it stagnate while housing prices soar,” said Rep. Ginny Brown-Waite, author of the bill. The Senate is now debating a companion bill. * * * FHA Limits Also Rising Another legislative proposal now working its way through Congress would raise the ceiling of FHA insured mortgages to 100 percent of a local area’s median home price. It’s a step that is strongly supported by most real estate organizations. “The Mortgage Bankers Association believes that raising FHA’s loan limits will broaden the housing stock available to FHA borrowers in many high-cost areas without shifting FHA from its focus on first-time homebuyers and the underserved,” said Jonathan Kempner, MBA president. * * * Subprime Mortgage Study The Subcommittee on Housing and Community Opportunity and the Subcommittee on Financial Institutions and Consumer Credit has been holding hearings to promote homeownership by ensuring liquidity in the subprime mortgage market. The subprime mortgage market has helped millions of American families enjoy the dream of homeownership. In most cases, after a borrower closes a loan, the company making that loan sells it into the secondary mortgage market where it is packaged into a Mortgage Backed Security (MBS) and sold to investors. Consumers benefit from this flow of investment capital into the housing finance process because the steady resources lower rates, therefore making homeownership possible. Without the presence of the subprime mortgage market, over a million consumers each year would lose the chance to buy a home, refinance a mortgage, or tap into their home equity. * * * Home Sales Projections Rising Fueled by the outstanding financing climate and continued solid investment potential of new homes, sales of new single-family homes has been rising to a record-high seasonally adjusted annual rates, according to the Commerce Department. “This is one more report that confirms what builders in the field continue to report: buyer demand for new homes continues to be strong as the economic expansion strengthens and job growth accelerates,” said National Association of Home Builders (NAHB) president Bobby Rayburn. “Indeed, NAHB’s Housing Market Index for June shows continued high levels of home sales and builder confidence.” “In addition, thin inventories of unsold new homes are an indication of the continuing health and good balance of this market,” said Rayburn. “The recent extraordinary sales pace probably involved some acceleration of transactions in anticipation of higher interest rates down the line,” said NAHB Chief Economist David Seiders. “But it’s clear that underlying housing demand is quite strong and the current supply-demand balance is excellent. We are now forecasting that new home sales will hit another record in 2004. This powerful performance in the second quarter will certainly keep housing as a strong, positive component of the nation’s GDP.” * * * Government Responding to Needs of Homebuyers The government is becoming more consumer-friendly when it comes to homeownership, perhaps responding to increasing public pressure. One new piece of legislation, now progressively working its way through Congress, is the Zero Downpayment Act of 2004 (H.R. 3755). This is basically a bipartisan bill that would authorize the development of the zero-downpayment product for FHA mortgage borrowers. It was introduced earlier this year and is included in the president’s 2005 budget. But, as you might expect, it’s not without additional costs. This new legislation will expand the reach of FHA programs. As housing prices continue to rise, prospective homebuyers might qualify for an FHA loan but can’t come up with the downpayment and closing costs needed to consummate the transaction. The Zero Downpayment Act would eliminate this problem and create a new market of homebuyers. The new legislation would require borrowers to meet FHA’s underwriting criteria, but their downpayment and closing costs could be rolled into the loan. Borrowers would pay a higher upfront premium, have higher monthly premiums for five years, be required to attend pre-purchase counseling, and take on loans that have an interest rate that is a quarter of one percent higher than a traditional FHA loan. * * * More Interest in Lines of Credit Consumers are more aggressively taking out new home-equity credit lines. The number of such lines of credit jumped by 12 percent last year, according to the Department of Housing and Urban Development (HUD). The HUD study also noted that there was a total of 106 million occupied housing units nationwide last year. About 72 million of those units were owned by their occupants. Three million of those owner-occupied units were located in gated communities. Nearly 19 million had four or more bedrooms, an increase of about a million over year 2001. As for the vacancy rate for rental units, it rose from 7.8 percent in 2001 to 9.6 percent last year. * * * Commercial Real Estate Attracting New Investors An increasing number of investors, large and small, are turning to the commercial real estate market for their key investments, rather than relying on a stock portfolio. Some acquire commercial properties outright. Others participate in REITs (Real Estate Investment Trusts) or other forms of shared ownership. The REIT index increased 3 percent in June. This is a particularly good year for commercial real estate investments, according to a report from the National Association of Realtors. The improving economy and rising job market is resulting in growing demand for commercial real estate space. That demand will continue to increase throughout the year, NAR predicts. And that will ultimately produce rising rents for office, retail and warehouse space. That in turn will enhance the return and benefits of owning such properties, or sharing in the ownership. “About 1.2 million payroll jobs were added to the economy during the first five months of this year. We could see an average of 210,000 to 240,000 new jobs per month over the next two years, creating additional demand for commercial real estate,” said David Lereah, NAR’s chief economist. “A rise in leasing commercial space is expected over the course of this year. Rents are firming and all sectors can expect higher rents next year as vacancy rates decline,” he noted. Office properties dominate today’s investor interest, according to NAR president Walt McDonald. “Two out of five investment dollars spent in commercial real estate are on office buildings. During the first quarter of this year, $27 billion worth of commercial real estate traded hands. And 41 percent of that dollar volume was spent on office properties.” The amount of new office space in the design stage rose sharply during this year’s January-through-April period, according to McGraw-Hill Construction Dodge. The amount of office space entering the final planning and bidding state climbed in numbers by 70 percent over that time span. Properties used for retail operations are also up substantially from last year. The average vacancy rate for retail space is projected to drop to 12.4 percent this year, from 12.9 percent last year. Retail property rents should rise by 2.8 percent this year, and another 1.9 percent next year, the NAR report projected. There will be a healthy rise in warehouse leasing this year, it was also noted. The national vacancy rate is expected to average 10.1 percent this year, down from 10.5 percent last year. As for residential apartment buildings, the average vacancy rate is expected to hold at 7.1 percent this year, virtually unchanged from last year. Average rents will rise this year by 0.3 percent, and another 1.8 percent next year. | 
