Will Rate Cuts Kill the Housing Market?

The latest rate cut from the Fed was again good news for the stock market. Unlike the last several Fed moves, however, this one didn't make mortgage borrowers very happy.

The Fed has cut interest rates quickly and dramatically in recent weeks and months, and the entire yield curve has responded.  Although the interest rates that the Fed controls are all short-term rates, the rest of the bond market followed suit as yields fell across the board.  As a result, mortgage rates fell, and homebuyers seeking mortgages benefited greatly.

This time, however, it's a different story.  Although the Fed cut knocked another 0.5% off short-term rates, interest on fixed mortgages actually rose after the last rate cut announcement, making it harder for potential buyers to afford to buy a home.  And even if the Fed keeps cutting, there's no guarantee that any further action won't actually be counterproductive — at least as far as the housing market is concerned.

The rise in longer-term interest rates means those seeking a new mortgage may not get the lowest rates they might have hoped for.  But the recent moves actually re-establish a normal pattern in the bond market, where investors are rewarded with higher rates by committing their money for longer periods of time.  Unfortunately for savers, the normal-sloping yield curve came back mostly because of the huge drops on short-maturity bonds, which will reduce their income.

It would be ironic if the Fed's actions to try and stimulate the economy and prevent a catastrophic failure in the financial markets actually turned out to stifle a recovery.  Recent rallies on Wall Street with major homebuilders suggest the industry isn't worried yet.  But if rate cuts continue and the mortgage market doesn't cooperate, those higher stock prices could evaporate in a hurry — and you might miss out on the lowest mortgage rates in a generation.

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Home Equity Loan Defaults Soar

One of the last sources of ready cash for homeowners looking to get money from their house appears to be shutting down and the results aren't likely to be pretty for the economy.

The structure of these loans appears to spell trouble for many home lenders with big home equity loan books.  According to an overlooked Moody's Investors Services note that came out recently, once a certain threshold of losses is achieved in a home equity loan securitization pool, the bond holder is paid off ahead of the lender.

What's worse is that it's difficult to see how large a lender's exposure is to home equity loans.  Known as rapid amortization, this risk is treated as a contingent liability for many home equity loan lenders and is carried off balance sheet, until deterioration occurs and the lender goes on the hook for the loans.

In the short-term, this is just another blow for investors in the financial sector.  Longer-term however, it looks like a lot of ready cash is getting taken away from homeowners in some states.  Coupled with rising unemployment, this could pose a major headache for already strapped homeowners.

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