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TheStreet Open House

Higher Mortgage Rates Won't Hurt Housing Affordability: Freddie Mac

NEW YORK ( TheStreet) -- Mortgage rates will have to rise as high as 7% before home purchases becomes unaffordable in most parts of the country, according to economists at housing giant Freddie Mac.

The economists estimate that median-income families can afford to purchase a median-priced home with a 10% down payment and a 30-year fixed-rate mortgage in most parts of the country with the exception of some high-cost markets (primarily San Francisco south to San Diego, and Washington, D.C., north to Boston).

Affordability is calculated by requiring that principal, interest, taxes and insurance not exceed 28% of gross monthly income.

According to the economists, most of these markets can easily absorb the impact of higher interest rates without derailing the housing recovery.

Here's a chart on how rising interest rates impact affordability in the top 30 metros.

"With homebuyer affordability remaining very high, we expect that rising interest rates will have only a small, slowing effect on the home purchase market," economists Frank Nothaft and Leonard Kiefer wrote in a report.

Ultra-low mortgage rates has helped fuel a housing recovery over the past year. In recent months, however, a blend of fear that the Federal Reserve will ease its quantitative easing program and improving confidence in the economy has sent interest rates higher.

The 30-year mortgage rate has moved from about 3.4% to about 4% since May. The speed of the rise in rates and the likelihood of further increases as the economy improves have raised concerns about the sustainability of the housing recovery.

But the Freddie Mac economists believe the concerns are overdone with real interest rates -- interest rates adjusted for inflation -- still half of what they were prior to the recession. The recent capital market action will, if anything, draw buyers into the housing market. "The capital-market signal is that rates are up from the cyclical trough and are likely to move gradually higher in the coming year. In the short term this may spur renters and other first-time homebuyers who have the financial capacity, to get off the fence and buy a home before financing costs go higher," they wrote.

The outlook for refinancing is however much more pessimistic, given that it is a lot more rate-sensitive. The economists expect refinancing volume to touch $1.1 trillion in 2013, down from $1.5 trillion in 2012.

The economists cite Bureau of Economic Analysis data that shows the average effective interest rates on mortgages to be 4.7%, less than a percentage point higher than the 30-year rate Freddie Mac fixed-rate mortgage rate of 4%. The slim differential may reduce the incentive to refinance.

-- Written by Shanthi Bharatwaj New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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