Recognizing Market Realities

No major industry has been hit harder than housing by Washington's fight against inflation. By tightening credit, the Federal Reserve Board has sharply cut the supply of mortgage money; over the past twelve months, starts of new homes and apartments have dropped by 25%. Last week the Administration reluctantly raised the interest-rate ceiling on Government-backed home mortgages in an effort to draw more funds into homebuilding. The rate went up from 7 1/2% to a record 8 1/2%, effective this week, for Federal Housing Administration and Veterans Administration home loans. Because FHA borrowers must also pay a 1/2% insurance fee, the actual cost of FHA loans will rise to 9%.

George Romney, Secretary of Housing and Urban Development, said that he acted in response to "the realities of the marketplace." Yields on almost all long-term investments have risen by well over 1% since last January, when the FHA and VA rates were lifted from 6 3/4% to 7 1/2%. Recently, lenders have been willing to make mortgage loans at the 7 1/2% rate only by charging discounts as high as ten points--that is, advancing $9 for every $10 that must be repaid. The discount brings the return to lenders in line with that of competing investments, but sellers of existing houses and builders of new ones have either had to absorb the discount or add it to the selling price.

At the new 8 1/2% rate, discounts on FHA and VA loans should drop sharply, except in four states and the District of Columbia, which have legal limits below 8 1/2% for FHA and VA mortgages. In those five jurisdictions, lenders are likely to be more unwilling than before to make FHA and VA home loans at all. The 1% increase in the mortgage rate will add $4,473 to the cost of buying a $25,000 home with a 25-year loan and a minimum down payment of $2,500.

The Administration contends that the solution for housing's plight is to cure inflation, which should not only allow all interest rates to decline but increase the flow of money into the prime sources of mortgage loans: savings and loan associations and savings banks. That may take some time. Meanwhile, the nation's output of housing is likely to decline further and the high price of home loans seems certain to fan demands in Congress for measures to funnel less costly money into home financing.

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