The Impact of Rising Mortgage Rates

Mortgage rates will be starting to rise from this week on.  From the 3.9 to 4.0 percent average rate in the past five months on a 30-year fixed mortgage, the new rates will soon be in the range of 4.3 to 4.6 percent.  Usually the initial phase of rising rates can quicken the decision to sign on the dotted line as consumers do not want to face even higher mortgage rates later on.  However, a prolonged increase will shrink the pool of eligible home buyers.

Here are some raw statistics to contend with.  Let’s say a person is committed to paying at most $1,000 per month in principal and interest to be comfortably within this person’s budget.  A mortgage calculator will spit out that at a 3.9 percent rate (last week’s rate), this homebuyer will be able to take out $212,000 in mortgage amount.  At 4.5 percent (near future rate), the figure drops to $198,000, or the equivalent to a drop of 7 percent in purchasing power.  The homebuyer therefore has to shoot for lower price points.

Another way to view the impact of rising rates is to compute the income required to get the $212,000 in mortgage funds as in the above example.  At 3.9 percent, the income would have to be $4,000 per month, assuming that this particular person only feels comfortable with a mortgage payment taking up 25 percent of his or her income.  At 4.5 percent, the mortgage payment to buy that same home would be $1,074 per month and the corresponding monthly income requirement would be $4,296.  Now, how many people have a monthly income between $4,000 and $4,296 or on an annual basis between $48,000 and $51,552?  According to the Census income distribution table, 2.9 percent of the population is between these two incomes.  This income gap also represents how many people would have qualified to buy this particular example home before and after the mortgage rate change.

Simply put, if mortgage rates rise to around 4.5 percent in the upcoming weeks from the previous 3.9 percent, then home sales are expected to be impacted by 3 percent.  If the 30-year fixed mortgage rate rises to 5 percent then the impact is closer to 6 percent.

This illustration is what economists call a static analysis.  It assumes that other variables are not changing.  In the real world, the confluence of factors makes the data analysis less clean.  The 3 percent impact may not be meaningful if, say, job gains pick up steam or mortgage underwriting standards become less restrictive.  Then there are the cash buyers, making up about one-third of all buyers in the past year, who would care squat about rate changes. Still, it is worth keeping in mind that rising rates will put some drag on the broader housing market recovery.

 

by Lawrence Yun Chief Economist National Association of Realtors Mar 16, 2012

The Impact of Rising Mortgage Rates

Commercial Mortgage Lending: LIBOR vs. Fixed-Rate Loans

Commercial lending has gotten more complex in recent years as banks increase lending restrictions and get choosier about their lending clients. One significant change is the shift from offering long-term fixed-rate commercial mortgages to using the London InterBank Office Rate (LIBOR), which is a rate determined on a daily basis by the British Banker’s Association. These types of variable-rate loans shift according to market trends and is usually conveyed to the borrower at the start of the loan negotiation as a spread above a specific LIBOR rate. Obviously, these types of loans make it difficult for the borrower to determine the final cost of the loan, so many banks will offer an “interest swap” product that will cover a certain percentage of the unknown value. For more on this continue reading the following article from JDSupra.

If you have been involved in commercial mortgage financing during the past decade, whether as a borrower, lender, or legal counsel, you have likely been a witness to the changes that have taken place in the manner in which loan interest rates are set and adjusted.  For most sophisticated institutional lenders, long gone are the days of long term, fixed interest rates, which remain unchanged throughout the life of the loan.  Instead, many lenders now quote interest rates which either “float” with market conditions or, frequently, adjust to reflect the latest market trends.

The benchmark used by many lending sources to set loan interest rates is “LIBOR.” “LIBOR,” an acronym for the London InterBank Offered Rate, refers to an averaged rate, which is determined on a daily basis on behalf of the British Bankers’ Association.  It measures the cost at which a member bank can borrow from other member banks, on an unsecured basis, for a certain time period utilizing a given currency.  The LIBOR rate is calculated for 10 currencies and for 15 maturities, ranging from overnight borrowing to a 12-month loan period.

It is common to see commercial mortgage lenders quote proposed interest rates based on a “spread” above a specific LIBOR rate, which rate is automatically readjusted at the end of each LIBOR period.  For instance, the lender may quote an interest rate of 3.00% above one month LIBOR, which will adjust monthly at the end of each one-month LIBOR cycle.

Such variable rate loan pricing creates potential uncertainty as to the ultimate borrowing costs for a transaction.  In order to bring some certainty and stability, many lenders offer their borrowers “interest swap” products, pursuant to which the borrower exchanges its variable rate loan obligation for a fixed rate obligation.  The swapped, fixed rate is somewhat higher than the then current variable rate obligation.

Variable interest rate loan documentation, whether based on LIBOR or some other benchmark, requires careful drafting and negotiation to be certain that the details of the interest rate calculations, loan amortization, and swap features are properly covered. Therefore, it is important to consult with an experienced business and commercial financing lawyer.

by Robert Marsico NuWire Investor Mar 12, 2012

Commercial Mortgage Lending: LIBOR vs. Fixed-Rate Loans