Rising Rates May Slow Housing Bubble: Citi

NEW YORK ( TheStreet) - Rising interest rates could slow the pace of home price appreciation unless incomes rise, Citigroup housing analyst Will Randow said in a report Friday.

This could actually be a good thing, according to the analyst.

"We believe that slower home price appreciation likely is healthy, compared to the recent 13% YoY jump in the S&P/Case-Shiller Home Price Index, as fast moving home prices could ultimately create another housing bubble (i.e. overvaluation) if interest rates did not respond as a governor," he said.

Interest rates have moved rapidly over the past month after Federal Reserve Chairman Ben Bernanke said the central bank may begin to wind down its massive bond- purchase program later this year, though it will keep short-term interest rates low until 2015.

Over the past month, the 30-year mortgage rate has risen from 3.35% on May 2, to 4.46% as of June 27.

The speed of the move has caught market participants by surprise and raised concerns about the sustainability of the nascent housing recovery, which has been fueled by rock-bottom interest rates.

Randow notes that despite the rise in interest rates, from a historical perspective, housing affordability is "still in good shape." He estimates mortgage rates need to rise to 6% to 7% before the family home price-to-income ratio is in parity with the 15-year average.

However, he does expect rising interest rates to dampen affordability levels. A 1 percentage point increase in mortgage rates would require $1,500 more in annual median family income to not impact housing affordability, assuming a 20% downpayment, according to the analyst. Or incomes need to grow 2% for every 1 percentage point rise in mortgage rates.

In the absence of a rise in incomes, affordability will likely take a hit, slowing the pace of home price appreciation.

Randow already sees signs home price gains will moderate in the next few months. Existing home inventory is already up 15% year to date and with rising prices, more upside-down homeowners are returning to positive equity and will be in a position to sell. So inventory will likely pick up in the coming months, cooling home prices.

-- Written by Shanthi Bharatwaj in New York.

>Contact by Email.

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

If you liked this article you might like

Housing Data Drives Down Homebuilding Stocks

Strong Housing Numbers Boost Home Construction ETFs

5 ETFs to Buy if You Like Lowe's Fourth-Quarter Earnings