An Unexpected (but Welcome) Consequence of Rising Mortgage Rates

Common sense seems to dictate that rising mortgage rates will hurt the housing market by depressing the demand for purchase-money mortgages. But here's the thing: The data suggests that the exact opposite may be occurring.

At the end of last week, the nation's two largest mortgage originators, Wells Fargo and JPMorgan Chase , released earnings for the second quarter. Insofar as headline numbers go, both banks had stellar quarters, netting $5.5 billion and $6.5 billion, respectively -- Citigroup , which reported today, had a similar experience.

But if you dig a bit further, and into their mortgage operations specifically, the story is more nuanced. As expected, the volume of refinance mortgages fell markedly relative to the first quarter. Wells Fargo's dropped by 17% and JPMorgan's by 6%.


Unexpectedly, however, both banks reported dramatic sequential upticks in purchase-money mortgage originations. Volume at Wells Fargo was 46% higher than the first quarter, and JPMorgan reported an improvement of 44%.

I say "unexpectedly" because of what we've seen happen to mortgage rates since the Federal Reserve first hinted on May 22 that it may begin to taper its support for the economy. Following the announcement, the rate on a 30-year fixed-rate mortgage went from 3.35% at the beginning of May all the way up to 4.51% today.

As the price of a mortgage goes up via the interest rate, conventional economics tells us, the demand for one should go down. But clearly that's not happening here.

There are at least two explanations for this apparent paradox. The first is that homebuyers are rushing to lock in current rates, which are still exceptionally low on a historical basis, before they head higher.

"I'm afraid we're going to miss the boat," an aspiring homeowner recently told CNBC's Diana Olick. "I feel like we might get priced out of the market in a few months, and just depending on the mortgage payment whether we could afford it if the interest rates go up more."

The problem with this conclusion is that purchase-money mortgage applications are going down. You can see this in the figure below, which charts the Mortgage Bankers Association's index for purchase-money and refinance mortgages.

While applications for purchase-money mortgages may not have taken as dramatic a dive as refinance applications, one can't help but notice a subtle downward slope over the past two months.

It's for this reason that I prefer the second explanation. Namely, given the precipitous decline in refinance applications, mortgage lenders now have both the motive and the opportunity to pursue purchase-money mortgages.

The motive stems from the twilight of the refinancing wave. In Wells Fargo's case -- which matters disproportionately because it controls upwards of a third of the domestic mortgage market -- the revenue hole is huge. Last quarter was the seventh consecutive time that it had more than $100 billion in mortgage originations. In the vast majority of those quarters, roughly two-thirds of the volume related to refinancing activity.

And the opportunity is similarly grounded, given the vast quantity of manpower that the bank can -- and, at least in part, will -- redirect to originating purchase-money mortgages.

The net result is that, while the absolute number of purchase-money applications might decline in the face of rising interest rates, the proportion of them that are approved by lenders may be on the ascent.

For anybody who cares about the housing market -- and I say that somewhat facetiously because, as my colleague Morgan Housel has noted, "there hasn't been a strong economy without a strong housing market in modern history" -- this is very good news, as it supports the idea that home sales will continue their upward momentum.

It's estimated that every single-family home built by the likes of D.R. Horton and PulteGroup generates between two and three sustainable jobs. In addition, an increase in demand for housing will presumably push home prices higher, which will reduce the number of underwater homeowners and thereby spur consumer spending. It is, indeed, a virtuous circle.

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The article An Unexpected (but Welcome) Consequence of Rising Mortgage Rates originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Citigroup, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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