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Rising mortgage rates add to housing woes

Higher mortgage rates since March are tied in part to investors' inflation worries.

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Mr. Moulton recounts the tale of a client who wanted to refinance a condo in New York City. But the individual worked for Bear Stearns, the investment bank that was recently absorbed by Chase. "The lender wanted a letter guaranteeing his employment, which could not be obtained," he says. "And the loan was not approved."

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Lenders also are leery about lending money to individuals who are right on the edge of being able to afford their monthly payment. Banks assessing a loan application typically divide the applicant's income into thirds, explains Rob Harrington of OptHome, an online consumer resource on loans. One-third goes toward taxes; a second third is for housing, such as the mortgage payment; and the last third is for household expenses.

"But if household expenses are rising, such as higher prices for gasoline, where is the money coming from?" he says. "People coming after mortgages today don't have as much disposable income."

The rise in mortgage rates also affects a key factor in assessing a bank loan: the applicant's debt-to-income ratio. Pulling out a loan application for a $295,000 refinancing, Matthew Graham, a mortgage broker for Excalibur Inc. in Portland, Ore., says a mortgage rate of 6 percent would result in a debt-to-income ratio of 43 percent for that client. But with mortgage rates now closer to 7 percent, the ratio for his client shoots up to 46 percent because the debt portion of the loan has increased.

"Now, instead of financing $295,000, the client can only do $265,000 – a $30,000 decrease according to the underwriting guidelines," says Mr. Graham, who is also a columnist for "In a worst-case scenario, he can't refinance to pay off the mortgage and has to go into foreclosure."

The rate increases come as delinquencies and foreclosures continue to rise.

"We have not seen any improvement," says Jon Thompson, a vice president of St. Paul-based Advantus Capital Management, which purchases loans.

Mr. Thompson says some analysts worry that the housing and mortgage market is locked in a vicious spiral. It starts with falling home prices, which are reflected in lower-valued mortgages. Investors take write-downs of their mortgage portfolios and need to raise new capital. Lenders tighten lending standards, which cuts the number of potential buyers. Fewer buyers means home prices must fall further, restarting the cycle.

Falling home prices, however, are starting to make housing more affordable.

"Affordability has risen sharply," says Bob Brusca of Fact and Opinion Economics in New York. "In February homes were the most affordable they have been since March of 2003, but with this rise in mortgage rates affordability is starting to backtrack."