Will the Market Move Along With Mortgage Rates?

In the past year while mortgage interest rates have hovered near record lows, refinances have ruled the market. According to one analysis, that may be about to change.

Mortgage rates have already spiked since the election. The average 30-year FRM increased by 48 basis points in the two-week period from November 9 to November 23, according to Freddie Mac. And with that increase, a change has taken place in the market, according to First American’s October 2016 Loan Application Defect Index released Wednesday.

“The post-election sudden increase in mortgage rates has accelerated the shift away from a refinance-driven market toward a purchase-dominated market,” said Mark Fleming, chief economist at First American. “Based on analysis of loan application defect risk trends, purchase loans are riskier, so I expect that the overall decline in loan application and defect risk will slow as rates continue to rise into 2017 and the share of higher risk purchase loans increases.”

Fleming added, “The purchase-pivot will only happen more quickly now that rates are rising and likely to rise modestly next year. For lenders this also means that success moving forward will depend on how well they can also pivot their business models from refinance to purchase lending. Purchase lending generally requires more effort. In particular there will be heightened competition among lenders for first-time homebuyers. Many have already pivoted or are in the process and will be well prepared for the future. Other’s may decide that purchase lending isn’t their business forte and adjust accordingly. Nonetheless, the purchase-pivot is actually a return to a more historically normal relative balance of refinance and purchase activity and millennial driven first-time homebuyer purchase demand is only going to grow in the coming.”

Freddie Mac Chief Economist Sean Becketti concurred with the sentiment that rising rates will mean fewer refinances, according to Freddie Mac's November 2016 Outlook.

“Much like in 2013, we expect housing markets to respond negatively to higher mortgage rates -- they will drive down homebuyer affordability, dampen demand and weaken home sales, soften house price growth, and slow the growth in new home construction,” Becketti said. “And mortgage market activity will be significantly reduced by higher mortgage rates, especially refinance originations, which are likely to be cut in half.”

First American's Loan Application Defect Index estimates the how frequently defects, fraudulent information, or misrepresentation occurs in the information applicants submit in their mortgage loan applications, according to First American. The index declined by 14 percent in October compared with the same month last year and is down by 33 percent from its peak in October 2013, First American reported.

The Defect Indices for both refinance transactions and purchase transactions were down over-the-year in October, by 16 percent and 6 percent, respectively, according to First American.

Fleming said October’s Index showed that a noticeable divide was forming between the North and the South when it came to application defect risk.

“Defect, fraud and misrepresentation risk can vary substantially by location. In fact, the most recent data is showing a growing division between the North and South,” said Fleming. “Cotton states in the South are showing the highest levels of risk, compared to the northern rust-belt, where application and defect risk is currently the lowest. Defect risk is concentrating in the South, particularly in Arkansas and Louisiana, as well as in large markets in Texas and South Carolina.”

Markets in the South that rank high among the top 100 metros for defect risk are New Orleans, Baton Rouge, Little Rock, McAllen (Texas), Houston, Columbia (South Carolina), Birmingham, and Charleston.

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