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Whether you like it or not, mortgage interest rates are a big driver of the housing market. We’ve been spoiled with ultra-low rates the past few years, with many experts predicting that 2014 would be the year of 5% rates. They were wrong. Furthermore, we’re not going to be seeing 5% mortgage rates anytime soon – here’s why.

Credit’s Still Tight

Reality check: As a homebuyer, you either fit the box or you don’t.

Recently, Fannie Mae announced home lending is about to get easier for some borrowers by lowering the minimum down payment to buy a home from 5% to 3%. While this is a step in the right direction, it doesn’t make up for the macro-lending constraints still in place today. Mortgage underwriting has removed the human factor in making “makes sense” loan scenarios and reduced it to a paper checklist anyone can follow.

Case in point: A loan borrower with a 620 credit score and a previous foreclosure, along with a pattern of derogatory credit can easily apply for an FHA Loan with only 3.5% down and be approved. Compare to a borrower with an 800 credit score, an impeccable payment history, a 40% down payment and a 46% debt-to-income ratio. Today’s lending environment would suggest the borrower with the 800 credit score on a conventional loan would be larger credit risk because their debt to income ratio is just one percentage point over the 45% max debt ratio allowance.

This underwriting concept is a byproduct of the strict lending brought on by the government to reduce overall credit risk within the mortgage markets. While credit might be loosening in small niche areas, like helping first-time home buyers by allowing lower down payment options, the overall market is still incredibly tight. The main separator is that the human element of making a pragmatic lending decision is no longer acceptable by Fannie Mae or Freddie Mac. Instead, lenders now exercise caution when going down the checklist in order to approve a loan application.

Credit & Rates Go Hand-in-Hand

As long the ability to obtain credit continues to be tough, the prospect of mortgage rates rising to 5% is not likely to occur. Here’s why higher rates cannot be supported in the long term by today’s mortgage underwriting approach…

If interest rates were to rise to, say, 5% from the 4% levels they are at now, that would wipe out many potential buyers from the market, causing housing prices to fall because fewer people can afford homes with 5% loans than they can with 4% loans. Higher rates consequently would shut off refinance volume — the other profit pool lenders rely on in new loan activity.

If people are taking out fewer mortgages because interest rates have shot up, the housing market could suffer another collapse. In other words, if rates rise, one of two things could follow suit to offset the risk. Either the Federal Reserve would make an unprecedented move back into a quantitative easing policy, pumping money back into the mortgage market to lower rates to further support housing, or they would began loosening lending guidelines more aggressively to keep the flow of new mortgage originations constant. In short, the housing environment is likely too weak to be dealt the onslaught of 5% mortgage rates. If rates did creep that high, it could be short-lived at best under the current banking standards.

Supporting Higher Rates

The mortgage industry would have to reduce credit standards (allowing more loans to be made) to offset the risk of less mortgage volume. Lowering standards, not to where they were at from 2004-2007, but making them much less strict than the guidelines currently in place would be the option rather than purchasing mortgage securities again.

For example, one approach would be allowing for slightly higher debt ratios on conventional loans with compensating factors (stronger in one area to offset a lower area) to approve. This might mean allowing a debt-to-income ratio as high as 48% to qualify, rather than the 45% threshold. Alternatively, allowing stated income loans for the self-employed borrowers or showing alternative forms of documentation for the self-employed borrowers, such as bank deposits for income calculation, rather than solely relying on tax returns or other methods.

Tiny incremental changes like this would open up the door for people who otherwise are not getting loans in today’s environment. Another change may be allowing homeowners to refinance without loan-to-value restriction, even if their loan is not HARP 2.0 eligible.

As it is, the federal government has stopped buying mortgage-backed securities. The economy is improving, a further catalyst that rates will rise at some point.

When to Worry About Higher Mortgage Rates

When mortgages are easier to obtain, then you can start being concerned about the extra interest and how much more that home will cost you. Until then, mortgage rates are more likely to stay in the low-4% range throughout 2015, with perhaps a few intermittent spikes as high as 4.75%.

Another way to ensure you get the best rates possible is to keep your credit in good shape so you’re in a better position to buy when the time comes. You can use this calculator to see how much home you can afford, and you can see your free credit report summary every month on Credit.com to see where you stand.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.

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