NEW YORK (TheStreet) -- Although people borrowing money to buy a home typically want the lowest interest they can get, mortgage applications at Wells Fargo (WFC) - Get Report and Bank of America (BAC) - Get Report may actually increase once rates start to go up.
That doesn't turn traditional economic theory on its head the way it appears to, though: This is a case of synchronicity, not cause and effect.
Lenders and their lobbyists believe mortgage applications will rise in tandem with interest rates because higher rates would reflect broad U.S. economic improvement, which the Federal Reserve has said is a prerequisite. Lenders are confident enough, in fact, that the Mortgage Bankers Association raised its projection last week for home-purchase loans -- as opposed to refinancings -- by 9.7% to $801 billion this year.
"The stronger job market and somewhat higher levels of inflation will lead the Fed to hike in September, and we expect that mortgage rates will hit 4.5 percent by the end of the year," the association said in a statement. "The positive of the stronger job market will outweigh any negative of somewhat higher mortgage rates."
Indeed, the U.S. unemployment rate reached 5.3% in June, the lowest since the financial crisis and down from a peak of 10% in October 2009. If that helps the Fed boost rates, it could reverse higher refinancing applications relative to purchase loans in the past several years as current home-owners sought to take advantage of interest rates that the Fed cut to around zero during the financial crisis. Home-purchase applications were pressured because the weaker economy meant there were fewer eligible borrowers.
Of the mortgages that Wells Fargo funded during the second quarter, 54% were for home purchases, with the remainder representing refinancing, up from 45% in the first quarter, Tod Moriarty, home-lending finance chief for the consumer division, said in a statement. That reflected gains in home purchases as well as a decline in refinancings as interest rates inched upward, he said.
"There were still a significant number of refinance loans that funded in the second-quarter for customers who had applied and locked in lower rates" earlier, Moriarty said.
When the economy improves enough for the Fed to raise rates, the higher application volume isn't the only way banks will benefit. They will also see a higher spread between the interest they can charge on loans and what they pay on deposits, measured as net interest margin. That spread averaged 3.1 percent last year at the country's largest banks, significantly below its 10-year high of 3.9% before the crisis, according to a Bloomberg analysis.
Some evidence of the economic growth the Fed has been waiting for can already be found in mortgage-lending gains at both San Francisco-based Wells Fargo and Charlotte, N.C.-based Bank of America. The three months from April through June marked the best quarter for home loans at Wells Fargo since 2007, the company said earlier this month, and mortgage originations rose 44% at Bank of America.
But challenges remain in the short term: Bank of America's pipeline of applications shrank 15% from the first quarter and Wells Fargo's dropped 14% to $38 billion as rates started to move up.
"Some are surprised the mortgage market has not come back stronger," Wells Fargo CEO John Stumpf said on an earnings call earlier this month. "But we went through a pretty deep downturn. This was the asset class that had the problem in 2008 and 2009, and it's improving and healing, but it's going to take time."
The improving job market is helping, bringing "more people into eligibility for a purchase or refinancing," CFO John Shrewsberry said. Additionally, "while home prices have moved, they are still affordable," he said. "While rates have moved, they're still affordable, so that's helping a lot."
Some of the newly eligible home-buyers may be millennials who have found their economic footing since coming of age during the economic crisis. Born between 1980 and 2000, the generation is the largest in U.S. history; it now accounts for 32% of all new purchases, according to a recent survey by the National Association of Realtors.
"Buyers have come back in force, leading to the strongest past two months in sales since early 2007," Lawrence Yun, the group's chief economist said in an interview. "This wave of demand is being fueled by a year-plus of steady job growth and an improving economy that's giving more households the financial wherewithal and incentive to buy."
Wells Fargo has encountered a similar pattern, with first-time home buyers representing 30% of all home purchases during the second quarter, Moriarty said.
The gains aren't uniform, though. The Realtors Association said the share of sales to first-time buyers dropped 2 percentage points from May to June. As first-time buyers tend to be on the younger end of the spectrum, that may mean some millennials are being pushed out of the market just as they gain the salaries and savings that would normally enable them to own their own home.
"Limited inventory amidst strong demand continues to push home prices higher, leading to declining affordability," Yun said. "Local officials in recent years have rightly authorized permits for new apartment construction, but more needs to be done for condominiums and single-family homes."