How the Mortgage Market Will Look in 2011

This was kind of a bizarre year for the mortgage market. In the first half of the year, you had a decent number of home sales keeping mortgages for purchases stable, thanks to the home buyer credit. In the second half of the year, that changed as demand crumbled when the credit was withdrawn. At the same time, you had very low mortgage interest rates throughout much of the year cause a mini-refinancing boom. 2011 will look very different, as the housing demand continues to struggle and mortgage interest rates have begun rising.

Michele Lerner has a pretty good list of seven mortgage trends we can expect to see in 2011, over at Investopedia. A few are relatively trivial if you assume her first trend, rising mortgage interest rates, will hold. That will predictably continue to lower the demand for mortgages and refinancing, while increasing the portion of purchase applications. Lerner's last three predictions are a little more interesting, however.

First, she says that jumbo mortgages, those which exceed the conforming limit (between $417,000 and $729,750, depending on location) will become cheaper. Lerner notes that these mortgage interest rates were higher than conforming rates in 2009 and early 2010, but began to fall in the latter part of this year. This mostly has to do with the funding available for mortgages. Since the mortgage-backed securities (MBS) market died with the financial crisis, banks had to rely on government sources of financing. As investors become more comfortable again with private MBS, jumbo loans will become cheaper. For this to happen in 2011, the MBS market will have to improve accordingly.

Second, she says that all-cash purchases will become a larger part of the market. This will probably occur for a few reasons. One is that home buying demand is no longer as strong without the government credit in place. That means fewer consumers will be seeking mortgages. But investors weren't eligible for the credit anyway, so their demand will remain unchanged. As mortgage interest rates rise, they will magnify this phenomenon. Rising rates mean home buying will become even less attractive to many Americans. But again, investors with cash will be unaffected by interest rates, so their demand won't decline.

Finally, the mortgage loan process will continue to be cumbersome. This effect will likely be more significant for purchases of distressed properties, since foreclosuregate threw the industry into disarray. Moreover, as banks continue to struggle to fix their mortgage process in response to that crisis, delays will be inevitable. Lenders will be much more concerned with documentation and details than before. Going forward, they don't want to face the sorts of court challenges they're getting now due to shoddy record-keeping.

One thing Lerner didn't mention was the uncertainty banks will face in 2011. Not only do they have to contend with some new regulations stemming from this summer's massive financial reform bill, but the housing policy debate will heat up in Washington next year. That could cause banks to remain cautious about how many mortgages they write just before the rules of the game are set to change.

If you put all of this together, you get another very strange mortgage market in 2011. You won't see as much buying on the part of people who intend to live in their homes as their primary residence, so investors will become a bigger force in the market. Unfortunately, the number of investors is dwarfed by the number of consumers who want a house to live in, which means that demand will likely remain relatively low throughout the year. Meanwhile, banks will continue to be nervous in 2011, as the regulatory and funding challenges they face continue to evolve.