Mortgages: Bust, Fizzle or Just Fine In 2006?

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As interest rates slowly but surely rise, economists are predicting everything from a "bubble burst" to a "slow fizzle" in the mortgage market. The question now is, "Was 2005 a 'last call' for mortgages?"

"Clearly, 2005 was a surprising year to everyone regarding mortgage originations," said CUNA Mutual Group's Dave Colby. "We could be seeing a sort of 'Last Call' effect as interest rates continue to climb."

And while low interest rates made getting into home ownership particularly attractive, skyrocketing property values made it difficult, especially in certain high-priced markets, for many Americans to do so. The result: "exotic" mortgage loans.

"There were a lot more adjustable rate mortgages, and some interest-only mortgages," observed Colby, who is CUNA Mutual's chief economist. "There were some very strange ones out in California. There would be some severe heartburn at NCUA if they saw some of those go through at credit unions, but for the most part, credit unions stayed away from some of the more exotic mortgages."

But 2006 is likely to be a very different story. "The attractiveness of an ARM isn't what it used to be," Colby suggested. "Overall affordability is declining quite a bit. The opportunity to refinance for savings evaporates as rates go up, so we should see significantly lower mortgage origination volumes."

And what of the infamous housing bubble? "There has been much speculation and discussion of this, but the numbers we are seeing now do not trouble me," Colby offered. "We could see some noise and delinquencies from [hurricanes] Rita and Katrina, but there hasn't been enough time for us to see any defaults. In the Northeast and Midwest, home heating costs could cause some noise there, too. There's a lot of pressure, and it could trigger slightly higher delinquencies, but it's seasonal."

Despite rising rates, however, Colby suggested there are still some opportunities for CUs. "Mortgage origination volumes are going to be down, but there is an opportunity to create their own refi boom as members with ARMs at other financial institutions seek to lock in rates before that first adjustment comes calling," he noted. "Everyone is going to be hounding and schmoozing the Realtors for purchase money. Credit unions historically are not as good at purchase mortgages, but they can do a little credit counseling, which is right up their alley, when they see someone with an ARM that is about to adjust. If they do nothing, credit unions will see a substantial drop in mortgage originations."

CUNA's Bill Hampel agreed. "Credit unions have historically been better in the refi market than the purchase market, and when rates rise, the refi market declines," he said. "Most of the action is going to be in purchase. Unless credit unions take action to get a bigger share of their members' mortgages, volume will be off. It's going to be a real challenge because there will be an overall slowdown in both purchase and refi markets."

'Fizzle, Not Burst'

In markets where there are sharp price declines, loan quality could come into question, but Hampel said he doesn't believe there will be any of those. "I was one of the people on the bubble side, but I have come to believe it will not be a burst but a fizzle," he observed. "I don't see really sharp declines forcing members to give the keys back to their credit unions. Even if higher rates means it is more difficult to sell a house at higher prices, rates don't necessarily make it harder for them to pay their loans, unless we are talking about some of these exotic loans, and credit unions really aren't into those. I do expect to see some pain outside of credit unions, the ones who really have a concentration in interest-only loans and other exotic loans. But I don't foresee a catastrophe, even for them. It would be really bad if higher rates were combined with a weak economy, but a strong economy will take a lot of the sting out."

For all the talk of rising rates, CUs-and consumers-should not lose sight of the fact that they're still not going to be all that high, historically speaking.

"Rates are going to move above 4.6% this year, but they're going to have to go up 100 to 150 basis points to really shut down the market," said NAFCU's Jeff Taylor. "Rates are still low when you look at them in context. We're still not even close to the 7s, 8s or 9s. The economy is going pretty well, unemployment is low, so even though demand won't be gangbusters, this isn't a bursting bubble."

The big variable in that equation, Taylor noted, is the use of the aforementioned exotic loans. "But there has been no tracking of exotic loans, so it's hard to say what will happen with them," he related. "They are not as common at credit unions as they are at some other lenders. And really, with the exception of California, no one is really heavily into exotic loans, and certainly not credit unions."

But some of the more pedestrian choices, such as option-ARMs, could cause a few waves here and there, he suggested. "The risk there is that people might not have understood what happens to their payment when interest rates spike," Taylor noted. "There will be some pain. People have mortgaged into big homes. But this won't be a real problem for credit unions."

Indeed, it would take a "perfect storm" of several economic factors to collide at once to create any significant worries on the mortgage front. "We'd have to have a major spike in rates and see unemployment really jump, and then there could be a problem," Taylor advised. "If enough things go wrong, and the plan was to move in five years before the ARM adjusts, that might be fine...but the risk is if you can't get out of the house."

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