No Road to Ruin; Mortgage Rates Are Rising, and So Are Fears of a Housing Bubble. Is KB, a Big Builder of Starter Homes, Worried? Not Yet

By McGinn, Daniel | Newsweek, September 20, 2004 | Go to article overview

No Road to Ruin; Mortgage Rates Are Rising, and So Are Fears of a Housing Bubble. Is KB, a Big Builder of Starter Homes, Worried? Not Yet


McGinn, Daniel, Newsweek


Byline: Daniel McGinn

For anyone who drools over home-makeover shows, visiting the KB Home studio in Las Vegas is like a child's trip to Disney World. The showroom is filled with granite counters, oak cabinetry, sleek appliances and young couples tricking out their dream home. This is where customers of KB, the nation's largest builder of entry-level homes, choose accessories, from superinsulated windows to built-in surround-sound speakers. The average buyer spends $25,000 on these options, but it seems painless thanks to the handy chart that studio director Miguel Hutton hands out at the door. The chart, with a sliding arrow pointing to the current mortgage rate, shows that $25,000 in upgrades will add just $145 to a monthly mortgage payment, or, as Hutton explains it, just "$35 a paycheck."

Such is the power of low interest rates, which have helped fuel the biggest run-up in home values in a generation. For years experts have debated whether skyrocketing home prices--up 9 percent nationally in the last year--have gotten out of hand. By now you're probably familiar with the arguments. Bears say Americans' disenchantment with the stock market has made them irrationally exuberant for real estate, leading to speculation. They see rents falling, and too many people taking out adjustable-rate mortgages to stretch to buy a home. Housing bulls note that nationwide home prices have never fallen year-over-year, that demand for housing exceeds supply in many markets and that low rates have helped keep homes affordable.

What's new in this debate is that interest rates have begun to climb: while 30-year mortgages are still below 6 percent, economists predict they'll be at 6.25 by December and higher next year. Some say they're hearing the housing bubble's first hiss of a leak. Home sales dipped in July; in some markets, real-estate agents report rising inventory and slower sales. In this environment, KB Home, which built 27,331 homes last year, is a canary in the coal mine. The reason: its mostly first-time buyers are thought to be especially sensitive to rising rates, since they typically have small down payments and stretch to buy as much house as they can. "First-time buyers are going to evaporate first," says John Talbott, author of "The Coming Crash in the Housing Market." "When interest rates increase, they're not going to qualify [for a mortgage], and when they disappear the impact will be felt throughout the market."

Back at KB headquarters in Los Angeles, Bruce Karatz has spent many hours disputing that logic. "I never stop trying to think what better way there would be to explain [it]," says Karatz, KB's chairman. While interest rates clearly affect home sales, he argues that jobs, income growth and demographics are far more important. "Events drive home buying, not interest rates," he says. Even if mortgage rates soared to 9 percent, people would continue having babies and moving to take new jobs--life changes that compel them to buy regardless of where rates are.

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No Road to Ruin; Mortgage Rates Are Rising, and So Are Fears of a Housing Bubble. Is KB, a Big Builder of Starter Homes, Worried? Not Yet
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