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Altered rates: builders should prepare for higher rates in the coming months.

THERE'S NO DOUBT ABOUT IT: THE CYCLICAL low in mortgage interest rates occurred back in June. Builders now face a persistently higher rate structure that is likely to gravitate still higher as the economic expansion accelerates over the balance of this year and in 2004.


While long-term interest rates already have moved up substantially from their June lows, fixed-rate home mortgages still are available at historically low rates. Furthermore, the increases in long rates have not been provoked by any tightening of monetary policy, unlike earlier periods of rising long-term rates. Indeed, on June 25 the Fed dropped the short-term rate under its control to the lowest level in 45 years, and on Aug. 12 the Fed committed to maintain that rate target "for a considerable period." This monetary policy stance should help keep long-term rates from running out of control.

But it's also fair to say that psychology rules the forward-looking bond market and that forecasting long-term rates is a bit of a crapshoot. Indeed, psychology in the markets reflects fears of upward rate pressures generated by a stronger economy, by Fed efforts to avoid deflation and raise the inflation rate, and by persistently large federal budget deficits. And the markets know that the Fed eventually will raise short-term rates. The NAHB's forecasts assume that the Fed will hold short rates steady until mid-2004 and that the long-term home mortgage rate will not move above 7 percent by late next year. But there are substantial upside risks on both fronts.


Builders should mine the adjustable-rate mortgage [ARM] market for all it's worth. With the Fed anchoring short term rates and with psychology driving long-term rates higher, ARMs have once again emerged as a key safety valve for builders. Rates and terms on ARMs can vary quite a bit across lenders in any particular market (unlike the market for fixed-rate loans), so it pays to shop hard for the best deals.

Builders also can offer their own incentives to buyers. A survey" of 300 builders conducted by the NAHB in August showed that a fair number of companies already had geared up marketing efforts and sales incentives, led--as usual--by the larger companies. Increased use of Realtors/brokers and inclusion of optional items in homes at no charge were out of the box first, and some companies had begun to pay closing costs for their buyers.

Interest rate buy downs had not been rolled out by many companies in our August survey, but the buy down is a natural for prospective buyers who prefer fixed-rate loans (over ARMs) but flinch at the going rates on these loans. In the past, two-to-one buy downs have been powerful sales tools, particularly for larger companies, and more builders can take advantage of this tool. Furthermore, these "seller concessions" fall within limits set by mortgage insurers and secondary market agencies. Thus, the cost of the buy down can be incorporated in the house price, creating a win-win situation for all concerned.

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Title Annotation:Seiders Economy
Author:Sheikhli, Stephen
Geographic Code:1USA
Date:Oct 1, 2003
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