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Home Buyers: A Borrowed Dime Grows More Costly
Higher Mortgage Rates Reflect Inflation Fears

By Nell Henderson
Washington Post Staff Writer
Sunday, June 17, 2007

The price of money has gone up.

Or more technically, long-term interest rates have jumped in recent weeks, rattling the already slumping housing market.

When potential home buyers call for mortgage rate quotes these days, "they're shocked; they almost don't believe you," said Jim Foley, senior vice president of George Mason Mortgage. "They're quick to get off the phone to make more calls."

The average rate on a 30-year, fixed-rate mortgage rose to 6.74 percent last week, up more than half a percentage point in four weeks, from 6.21 percent, according to mortgage financier Freddie Mac. That would boost the monthly payment on a $400,000 mortgage by $139.

Underlying the jump in interest rates was a shift in sentiment in the financial markets. Early this year, many investors worried about a possible recession, causing rates to fall. More recently, they have concluded that strong U.S. and global economic growth will sustain inflation pressures in the months ahead, pushing rates higher.

Consumers are also paying higher rates on new home-equity and auto loans than they would have two weeks ago. Many companies are facing higher borrowing costs.

Investors holding bonds purchased a few months ago have seen their prices drop, but they can now buy new bonds paying higher yields.

And rising interest rates tend to hurt the stock market, as they did two weeks ago. Stock prices battled back late last week, but investors are still worried that higher borrowing costs will squeeze company profits and that bonds will become a more attractive alternative.

Money is still relatively cheap by historical standards. But the recent increases have stunned borrowers accustomed to easy money in recent years.

The big question for many consumers and investors is where interest rates are headed. If they keep rising, that would likely prolong and deepen the housing slump, cool the stock market and slow the economy.

Already, local real estate professionals say, some home buyers have rushed to lock in mortgage rates before they move higher. Others are holding off in hope that rates will come back down.

Economists aren't much help because they are divided between those who expect long-term interest rates to climb higher and those who think they're more likely to settle around their current levels.

The Federal Reserve is widely expected to hold its key overnight interest rate steady at 5.25 percent when policymakers meet at the end of this month, and possibly through the rest of this year.

This rate, which has been steady for a year, is the benchmark for short-term rates such as those charged on credit cards and on many business loans, and those paid by banks to holders of certificates of deposit. These rates have not moved up in recent weeks.

Longer-term rates are influenced by the Fed but ultimately are determined by global capital markets, which are influenced by the changes in the supply of and demand for money and by investors' expectations for growth and inflation.

For example, a common benchmark, the yield on the 10-year Treasury note, reached 5.32 percent at one point last week, the highest level since April 2002 and up significantly from a low of 4.497 percent in early March. The yield fell Friday to 5.17 percent, after the Labor Department reported that inflation, excluding food and energy, was mild last month.

Long-term rates hit their lows in early March on fears of a recession. Pessimism peaked after the Dow Jones industrial average plunged more than 400 points in late February. Bankers also reported rising rates of home foreclosure and late mortgage payments, and many signs indicated economic growth had slowed to a crawl in the first three months of the year. Many bond traders bet a weakening economy would depress the demand for capital and prompt the Fed to cut short-term rates to stimulate growth.

Bad bet. Instead, the opposite occurred. The economy has rebounded, with retail sales, factory production and job growth all picking up in recent months, while unemployment remains low.

And instead of hinting at a rate cut, the Fed has emphasized its inflation worries.

The recent pop in rates shows "the bond market is finally realizing the Fed isn't going to cut rates this year," said Dean Junkans, chief investment officer of Wells Fargo Private Client Services.

Meanwhile, strong economic growth has fueled inflation pressures worldwide, prompting the central banks in Europe and New Zealand to raise interest rates two weeks ago. Analysts expect the European Central Bank and its counterparts in Britain, Japan and perhaps China to raise their rates in coming months, tightening the supply of money.

Rising rates appear less upsetting to borrowers who remember buying their first homes when 30-year rates were more than 7 percent or even in double digits during the 1970s and 1980s, Foley said. More recent home buyers are less accepting, he said. "I think we got spoiled by these rates in the 6's."

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