If mortgage rates rise permanently, what happens to the real estate market?

If rates rise in the U.S. permanently, what will happen to our real estate markets?

Fragile as it is, our own real estate market is in jeopardy of dying before it recovers. If rates rise permanently over 4%, it will not be good for the real estate psyche. Even though anything under 6% is incredibly cheap, comparatively speaking, people will get spooked. Some say higher rates will spark a buying frenzy while others say, it will come to a screeching halt.

I read an interesting article on mortgage rates, by Elaine Moore, in this Sunday’s Financial Times. Rates are rising and what is the effect on the consumer?

Rising mortgage rates threaten to cut short the fragile housing market recovery indicated by recent higher lending volumes, brokers have warned.

Two of the UK’s largest lenders have increased mortgage rates in the space of a week, blaming higher funding costs.

Halifax, part of the state-backed Lloyds Banking Group, and Royal Bank of Scotland , which is 83 per cent state-owned, both claimed they were passing on the increased cost of borrowing in wholesale markets.

Brokers say the changes pave the way for banks to impose even higher rates for potential first-time buyers, many of whom have been locked out of the property market by risk-averse lenders.

“If lenders continue to raise their rates those with the smallest deposits – the first-time buyers – will get hit hardest, because the risk they pose means they cost more to lend to,” said Mark Harris at SPF Private Clients, the high-end broker.

Halifax confirmed on Sunday that its variable rate would rise from 3.5 per cent to 3.99 per cent, explaining that the increase reflected the fact that raising money through retail savings and in the wholesale markets is currently very expensive by historical standards.

Hundreds of thousands of customers who reverted to the bank’s standard variable rate when their initial fixed or tracker mortgage deal came to an end will be affected by the change, which will add hundreds of pounds to the average annual mortgage bill.

RBS also announced over the weekend that it would raise the rate on two of its mortgage products by 25 basis points, and later Santander released plans to increase the rate on a number of its mortgages by 10 basis points.

Brokers and analysts say that banks would usually wait for an increase in the Bank of England base rate before pushing up their rates, but expectations that interest rates will remain at a historic low for months to come have forced their hand.

Three-month Libor, the average rate that banks borrow money from one another, has increased by 0.25 percentage points since autumn 2011 amid fears over the eurozone crisis. In turn, the extra demand for retail deposits as an alternative source of funding has led banks to offer costly incentives to savers.

So far 2012 has seen an unexpected up-tick in lending volumes, which analysts attribute partly to a first-time buyer renaissance.

Although deposit requirements for new borrowers remain more strict than they were before the crisis, there has been a rise in the number of high loan-to-value deals available to first-time buyers with deposits, according to the Ray Boulger of John Charcol, the mortgage broker. And the expiry of a stamp duty holiday in March may have provided an added incentive to buy now.

Grant Shapps, the housing minister, recently outlined the government’s new plan to raise buyer numbers. The NewBuy Guarantee Scheme will allow those with only a 5 per cent deposit the opportunity to purchase a new-build property.

Credit: Elaine Moore, in this Sunday’s Financial Times