By Colin Barr
February 15, 2011

Will rising interest rates slam the door on a fragile housing recovery?

No — though that only underscores just how grim the housing picture is.

The rate on the 30-year conforming mortgage has risen to a recent 5.1% from 4.2% last October (see chart, right), tagging along behind an even larger rise in the yield on the 10-year Treasury note over that period.

The jump in the mortgage rate has added around $50 to the monthly tab on a 30-year, fixed-rate mortgage on a median-price house ($170,000 or so) purchased with 20% down, estimates Paul Dales of Capital Economics in Toronto.

Those figures could yet rise further in coming weeks. Many observers expect the yield on the 10-year Treasury rise to 4% or above from a recent 3.6%, amid questions about whether U.S. policymakers have the guts to rein in the galloping U.S. budget deficit. Higher Treasury rates generally translate into higher mortgage rates.

Yet houses are cheap enough that mortgage rates could even rise further without drastically damaging the affordability picture, Dales says. He figures they could rise another point or two without really darkening the affordability picture, which for the past few years has been practically the only bright spot in the housing market.

The recent increase in mortgage rates means buying the median house consumes 14% of median income – up from 13% at the October low. That’s barely half of the 25% of income Americans were ill-advisely funneling into house purchases at the top of the housing bubble.

He also expects low house prices to limit the fallout of higher costs that will result from the Obama administration’s makeover of the deeply troubled U.S. mortgage finance system.

“Relatively low house prices mean that affordability remains very high by historical standards,” says Dales.

Unfortunately, that doesn’t mean a housing recovery is anywhere in sight. Few Americans have either the means or the inclination to plunk down $34,000 for a down payment on a house now, regardless of how reasonable the monthly payment might be.

That unwillingness to invest in housing only stands to increase now that house prices are falling in earnest again. House prices fell in 19 of the 20 biggest regions in November, S&P said in its latest survey of national house prices, and the Case Shiller indexes are down around 30% from their 2006 peaks, within a few points of their recent lows.

With the job picture still weak, foreclosures piling up and lending standards much tighter than they were a few years back, there’s no reason to believe the housing market will regain its footing any time soon — even if there are a few hardy souls willing to bet once again on adjustable rate mortgages.

“High affordability will still not prevent house prices from falling further,” says Dales.

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