Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of the U.S. Securitized Products Research from Morgan Stanley.
James Egan: And I'm James Egan, the other co-head of Securitized Products Research.
Jay Bacow: And on this edition of the podcast, we'll be talking about the impact of a rising rate environment on the U.S. housing and mortgage markets. It's Wednesday, April 7th, at 11 a.m. in New York.
Jay Bacow: Now, Jim, mortgage rates are now almost 60 basis points above their all time low, they set the low right at the beginning of this year at 2 and 5/8 percent, and now we're close to 3.2% per Freddie Mac's headline mortgage survey rate. What does this mean to borrowers that are looking to buy a house? Are homes still affordable, or should they look elsewhere?
James Egan: Great question. We're in a materially different place than we were. And when we think about how that flows through to the housing market, it's affordability. Not only are mortgage rates higher, but home prices themselves continue to move dramatically higher. The most recent print from Case Shiller had them up 11% year over year. Both of those things combined are going to mean that that monthly payment, the principal and interest payment that people make on their mortgage is going to be materially higher. So what does that mean? The median price of an existing home, the most recent point we have is $317,000. Let's assume a 20% down payment or an 80 LTV loan on that balance, we're talking a little over $250,000 worth of mortgage. And if we say what does 50 basis points mean on a $250,000 dollar mortgage? It's almost $70/month or a little more than $800/year, and that is not an insignificant amount.
James Egan: Now, when we think about affordability, we take that monthly principal and interest payment, and we think about what it is as a percentage of income. Now, if we were to take that 50 basis point move. That increases principal and interest payment as a percentage of income by almost an entire percentage point. That being said, if we take a step back and look at what this means from a long term perspective, we're not nearly as affordable as we were in the fourth quarter of 2020, but on a long run average basis, it still looks like housing is pretty affordable. So affordability is definitely deteriorating, but it's still in pretty decent shape.
Jay Bacow: Right now, Jim, when we think about the purchase market and we think about the payments that consumers are making, most mortgage payments are fixed at this point, right? How do you think about the impact of the rise in mortgage payments across different homeowners, given the payments that they're making?
James Egan: Right. So as you're saying, that almost $70 increase in mortgage payment isn't going to flow through to the current universe of homeowners, at least nearly as much as it would have historically. 2004, 2005, 2006, over 50% of all First lien mortgages in each of those years were adjustable rate. If we were still in an environment like that, this increase in mortgage rates could very well flow through to the consumer balance sheet.
James Egan: We're in a very different place today. 2020, we just had a record amount of First lien mortgage origination. Less than 7% of that were adjustable rate mortgages, 93% were fixed rate mortgages.
James Egan: So it's not this increase in mortgage rates flowing through to consumer balance sheets that really impacts kind of their bottom line, their monthly debt service costs. But what it does do is decrease their incentive to refinance. Jay, how are you thinking about that from a mortgage volume perspective? From a refinance perspective?
Jay Bacow: Well, the nice thing, about over 90% of homeowners having a fixed rate mortgage is it makes it pretty straightforward to calculate what percentage of those homeowners have enough incentive to go through the re-fi process, given all the frictions involved. And back when mortgage rates were at their all time low, over 90% of the homeowners did have incentive to refinance, given all of the frictions. With the rise in mortgage rates that we've seen, we're now down to just 50% of homeowners having, enough incentive to refinance to go through the process. This is a level that we saw back in March as we were going to enter the beginning of the quarantine process and the pandemic. Now, we think that the re-fi activity this time is going to be higher than the re-fi activity back then, despite homeowners having a similar incentive to refinance, for a few reasons. But probably the most important one is mortgage fintech.
James Egan: Yeah. So, Jay, a lot of the questions that we've been getting recently have been on mortgage fintech. And how can the improvements that we've seen there impact refinance speeds or refinance volumes, despite what we've seen in the mortgage rate environment. How are you thinking about those improvements in mortgage fintech?
Jay Bacow: There's a lot of room for mortgage fintech to make improvements across a variety of different areas. Maybe the simplest way to measure is the percentage of homeowners that no longer have to get their property inspected. They can get a waiver through an automated appraisal system. And when we look at that, there's different percentages of homeowners that get the property inspection waived, depending on if they're going to get a purchase or a re-fi. The number of homeowners that got a purchase inspection waived has more than doubled over the past year. The percentage of homeowners that got a re-fi inspection waived has gone from 45% to 67%. The number that have tried to get a cash out re-fi waived has gone up by more than a factor of 3 over the past year. So mortgage fintech is making a big difference. And we think despite having less incentive, it's one of the reasons why we think you're going to continue to have healthy re-fi environment.
Jay Bacow: Now Jim, you talked about affordability and how it's still, less affordable than it was in the fourth quarter. What is this rise in interest rates combined with mortgage fintech and everything else mean for your forecast for the housing market for the coming year?
James Egan: So when we think about how this impacts our housing forecast, we do think the transaction volumes, existing home sales, new home sales can continue to climb. They've had a good first quarter. But we do think that what it will mean from a home price perspective is that the pace of growth, the rate at which that is contributing to affordability declining, that's going to have to slow down. We think it will remain positive. We think we're going to continue to see mid single digit growth in home prices. But the most recent Case Shiller print was over 11%. It can't continue to outstrip incomes by as much as we are or outpace incomes by as much as we are from that perspective. So home price growth is going to have to slow, but purchase volumes can continue to climb.
James Egan: Now, Jay, what does all this mean with respect to the mortgage call? What are you telling investors from the mortgage market perspective?
Jay Bacow: It's a bit of a mixed message, Jim. The positive economic outlook that you laid out and our economists put out is obviously clearly positive for risk assets. And this manifestation of it, vis a vis an increase in interest rates, means that there is less re-fi activity, which is good for investors at agency mortgages. However, the continued purchase activity that you described means that there's going to be more supply coming to the market.
Jay Bacow: Now, that's the supply side. There's also the demand side. And the Fed has not changed their demand function. They're still continuing to buy $40B mortgages a month on a net basis and well over $125B mortgages a month on a gross basis. And so the technicals are still really strong.
Jay Bacow: Now, with that, Jim, it's always great speaking to you.
James Egan: Great talking with you, Jay.
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