By Gretchen Morgenson and Vikas Bajaj
New York Times News Service
July 13, 2007
They have provided consumers with dirt-cheap mortgages that fed the real estate boom. They have supplied easy credit to companies and investment firms, propelling stocks and corporate profits to record highs and fueling a buyout binge.
Now that party may be coming to an end.
Yields on the 10-year Treasury note -- a benchmark that influences many long-term interest rates, including home mortgages -- jumped sharply and are up significantly. The fallout is likely to be widespread, and felt most immediately by homeowners and people looking to buy homes.
Economists said homeowners trying to refinance their adjustable-rate mortgages before they reset to higher levels are already feeling pinched. The national average for the 30-year fixed-rate mortgage jumped to 6.74 percent recently. At the beginning of the year, the average was 6.18 percent, according to Freddie Mac, a big buyer of mortgages.
Last year, adjustable-rate loans accounted for 25 percent of mortgage applications, up from 11 percent in 1998, Freddie Mac said. Demand for adjustable-rate loans peaked in 2004 at 33 percent; many of those are at or near the reset point.
"It's going to be tough," said Adam L. Stein, president of the Washington Association of Mortgage Brokers near Seattle. "I talk to people every day looking to get the fixed rate. You give them the current rate and they say, 'That doesn't do anything for me.'"
Homeowners are not the only ones who will have to swallow higher costs. Corporations, accustomed to financing operations with cheap debt, will see their expenses rise, cutting into profits. In addition, rate increases will crimp the private-equity buyout boom, which has been fed in large part by the heavy issuance of corporate debt at low rates.
"There has been a half a percentage point rise in rates while inflation has been flat, so the real cost of capital has gone up for consumers and for corporate America," said Mickey Levy, chief economist at Bank of America. He said he expected the increase to put pressure on stocks and dampen already-weak demand for housing.
The recent rate move came as something of a surprise to Wall Street. It is the result, traders say, of heavy selling by foreign investors, who may be growing concerned about inflation, and holders of mortgage securities hoping to reduce the risks associated with higher rates.
While the Federal Reserve Board sets the nation's interest rate policy, buyers and sellers in the Treasury market drive the rates that affect both consumer and corporate borrowers. Bond yields rise when prices fall.
Some bond strategists said the recent rate spike is only the beginning. The sharp increase, they said, is just starting to bring interest rates back to their normal or long-term trend levels.
"Bond yields have been so low for so long," said Richard Suttmeier, chief market strategist at RightSide Advisors. "But yields in the 10-year have moved up almost 100 basis points [1 percent] since the end of February. That, to me, is a big shock and enough for people to take notice."
Particularly hard-hit will be consumers with weak credit -- known as subprime borrowers -- who are faced with mortgage rates that will soon reset to higher, in some cases double-digit, levels. Some $100 billion in subprime loans are scheduled to reset between now and October.
Even before the latest rate increase, borrowers who were refinancing their mortgages were paying higher prices to do so. In the first quarter of 2007, Freddie Mac said, one-half of the borrowers who paid off their original loans and took out new ones absorbed an average increase in interest rates of three-eighths of a percentage point.
Betty King, a 42-year-old single mother of two in St. Louis, would like to refinance the adjustable rate mortgage on her three-bedroom townhouse but cannot. Her $1,200 monthly payment would rise too much. Her loan, with a rate of 5.9 percent, is scheduled to reset next year.
"Right now, it doesn't pencil out for me," said King, who works part time at an online travel site so she can spend time with her teen-age daughters.
A.W. Pickel III, a mortgage banker who is working with King, said several clients were in similar predicaments.
"I don't think they are panicked," he said. "But now they are wishing, 'Why didn't I take a fixed rate three years ago when I had the chance and rates were low.'"
Higher rates are already contributing to an increase in foreclosures. The share of mortgages entering foreclosure in the first quarter of 2007 rose to 0.58 percent, the Mortgage Bankers Association said Thursday, up from 0.54 percent in the previous quarter.
RealtyTrac, an online provider of foreclosure data, reported that foreclosures in May were up 90 percent from the period a year earlier. Although RealtyTrac's figures may overstate matters somewhat by reflecting loans in each step of the foreclosure process, the total foreclosures of 176,137 in May were sobering.
For struggling homeowners, the rise in rates could not come at a worse time.
"In prior foreclosure waves, we had a drop in interest rates that allowed workouts to be done at lower interest rate levels," said Louis S. Barnes, a partner at Boulder West, a mortgage banking firm in Lafayette, Colo. "Today rates are substantially higher than when a lot of these loans were created."
In Florida, a glut of homes on the market combined with rising insurance premiums and higher interest rates will mean a slower recovery, said Patrice P. Yamato, a mortgage broker in Jacksonville.