Lower mortgage rates no silver bullet
The government is weighing plans to drive rates as low as 4.5%. But experts say that won't be enough to stabilize the housing market.
NEW YORK (CNNMoney.com) -- Reducing mortgage rates to a historically low 4.5% may entice some homebuyers out of the shadows, but it won't be enough to really spur housing sales, experts said.
Only a week after the Federal Reserve unveiled a $600 billion plan to reduce mortgage rates, the Treasury Department is considering adding to the effort to lower rates even more. Both moves are intended to get more buyers into the market in hopes of stabilizing home prices and reviving the economy.
While Treasury officials are keeping mum about the latest proposal, lobbyists said Thursday it is aimed at reducing rates to 4.5% only for people buying homes. Those looking to refinance would not qualify.
There's no doubt, experts say, that the government needs to provide incentives to homebuyers.
Until now, all efforts were focused on addressing the record number of mortgage delinquencies. This should remain the priority, experts say, but it should be coupled with increasing demand for homes.
Adjusting mortgage rates, however, will only go so far in getting prospective home buyers into the market, experts said. Potential buyers remain spooked by falling home prices and rising unemployment. And even those who want to buy cannot find loans with reasonable downpayments and terms.
"The problem is not interest rates," said Kenneth Rosen, chair of the Fisher Center for Real Estate at University of California, Berkeley. "It's the availability of credit."
And, of course, there's still the issue of stemming foreclosures. The Bush administration has been loathe to mandate widespread loan modifications. Instead, it is opting to chip away at the problem by adjusting loans held by Fannie Mae and Freddie Mac and by asking banks to expand their programs.
But even federal officials acknowledge the economy won't recover until the tidal wave of foreclosures ends. Federal Reserve Chairman Ben Bernanke Thursday said the government must do more to help struggling homeowners, possibly by buying delinquent mortgages and refinancing them to more affordable terms.
Lobbyists are ratcheting up pressure on federal officials to do more to entice homebuyers into the market. Various proposals have been floated, but lowering mortgage rates is among the more popular.
One of the more vocal industry groups, the National Association of Realtors, met with top Treasury officials last month to outline a plan to stabilize home prices through lower mortgage rates.
While details remain sketchy, its proposal calls for Treasury to subsidize rates so home buyers pay 4.5% for a 30-year fixed-rate mortgage. It would be similar to a homebuyer paying points -- a percentage of a home's value -- in return for a lower rate, but the government would foot the bill.
The plan would cost $50 billion, said Lawrence Yun, the group's chief economist.
Lowering rates to 4.5% -- about a percentage point below today's rate -- would spur 500,000 home sales over the next year, he said. That would put a big dent in the supply of 4.6 million homes on the market. Right now, there is a 10-month supply of homes for sale, three to four months more than in normal conditions.
A 4.5% mortgage rate would prompt many people to buy, even if they fear home prices will continue to fall and the economy to weaken, he said. Rates have not fallen below 5.37% for 45 years.
A wave of purchases should stabilize home values, which, in turn, will help the economy to turn around.
Last week's announcement by the Fed, which prompted a half-percentage point drop in rates, sent homebuyers' mortgage applications up 37.4%, according to the Mortgage Bankers Association.
"We need to do something to counter that pessimism," Yun said. "Doing nothing will exacerbate the problem."
Lowering rates is among several options the Treasury Department is considering. An announcement could come as early as next week.
Experts, however, questioned whether buyers would take advantage of lower rates. They criticized government officials for taking a piecemeal approach -- with narrow programs unveiled every week -- rather than coming up with a comprehensive plan to stabilize the housing market.
"I don't think they are thinking through what they are doing," Rosen said.
What's keeping many homebuyers out of the market are stringent lending standards, not interest rates, experts said. As long as credit remains tight and many banks require 20% downpayments, many buyers will remain on the sidelines.
Instead, banks should make mortgages available with a 5% or 10% downpayment, Rosen said. And while he doesn't advocate a return to the "mirror standard" (when borrowers could get money if they simply could fog a mirror), banks should allow more people to qualify for fixed-rate mortgages if they show sufficient income.
The government could also provide more incentives to homebuyers. Instituting a federal tax credit at closing to help cover costs would appeal to many purchasers, said James Gaines, research economist with the Real Estate Center at Texas A&M University. A $7,500 credit approved by Congress this summer -- which is really a loan since it must be paid back -- isn't working.
"It hasn't done any good," Gaines said. "Make it a real credit for home purchases."
Another option is to provide incentives for investors to buy properties and turn them into rentals, he said. This could be done with various tax incentives, such as eliminating capital gains tax on homes owned for more than five years.
Other experts said a mortgage-rate reduction could work, but only if it were done on a temporary basis. That would prompt people to take advantage of the lower rates while they last, said Edward Leamer, director of the UCLA Anderson Forecast, a quarterly economic review.
As the economy continues to weaken, however, some economists say the answer to the housing crisis lies in stabilizing the job market. As more people lose their incomes, more fall behind in their mortgages and lose their homes. This trend will accelerate the number of foreclosures and keep prices in a downward spiral.
If people fear for their jobs, or even worse, have no job, they will not make big-ticket purchases like a home, said Christian Menegatti, lead analyst for economic research firm RGE Monitor. That's why the government should consider an economic stimulus package that will help keep both home values and employment from declining.
"Potential homebuyers may not be in the condition to buy a home no matter what because of a job loss or a drop in income," he said. 
