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Higher Rates Won't Derail Housing Recovery: BofA Merrill Lynch

NEW YORK ( TheStreet) -- The spike in mortgage rates in recent weeks is likely to dampen the housing recovery temporarily but will not derail it, according to Bank of America Merrill Lynch economist Michelle Meyer.

The 30-year mortgage rate has jumped 56 basis points since early May to nearly 4%. While the rate is still low, Meyer acknowledged in a note to clients Wendesday that the speed of the increase may give homebuyers a reason for pause.

"Potential buyers who entered the market a few months ago set their price objective based on a lower mortgage rate. It will therefore be a payment shock when they look to receive financing at today's rates. Based on the average home value, this rise in rates is equivalent to an additional $50 in monthly payments," Meyer wrote.

According to Meyer's analysis, if home prices rise 8% this year and there is no change in interest rates, the affordability index will decline from its peak to early 2012 levels. If there is a 100 basis point increase in rates, the affordability index will likely decline to early 2011 levels.

For home affordability to remain at this level with a rise in interest rates, either incomes would have to grow 18% or home prices would have to fall 15%.

Meyer does not think either scenario is likely. So affordability has likely peaked. Still, affordability levels are high and confidence from rising home prices and potential loosening of credit could prove powerful counters to rising rates, she wrote.

Meyer expects home prices to rise 8% in 2013, suggesting a moderation in prices over the next few quarters. Price appreciation is likely to slow further to 6.5% in 2014.

Separately, Trulia economist Jed Kolko noted in a blog post Wednesday that interest rates will have to rise much more before it begins to substantially affect the decision to buy versus rent.

With a 3.9% 30-year fixed-rate mortgage (the most recent Freddie Mac rate) and 20% downpayment, buying is 41% cheaper than renting nationally, according to Kolko's calculations. The analysis assumes the borrower will stay in the home for seven years and will deduct property taxes and maintenance at the 25% tax bracket.
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