The current outlook for the housing market is less than robust, with housing indicators expected to decline this year. Based on projections from Fannie Mae, Freddie Mac and the Mortgage Bankers Association, for instance, housing starts are expected to drop 6.3% to 1.92 million from last year. Meanwhile, existing home sales are projected to decline 6.2% to 6.60 million with new home sales slightly lower at -4.9%, dropping to 1.21 million.

While lower, these numbers would still roughly be the third highest on record. Contributing to the limited slowing in the housing market are positive housing fundamentals such as strong demographic trends - in part from minority and immigrant households - and the economy. Merrill Lynch analysts cite as positive factors modest supply and the expanding universe of affordable mortgage products, allowing consumers to afford more expensive homes.

Fixed mortgage rates are not expected to rise sharply in 2006, while ARM rates are predicted to climb more dramatically due to additional Federal Reserve rate hikes. The 30-year fixed mortgage rate is anticipated to average 6.44%, up 55 basis points from the 2005 figure, while one-year ARM rates are projected to rise 96 basis points on average to 5.46%. This would narrow the fixed versus adjustable rate spread to 98 basis points from 140 basis points in 2005. Despite the tighter spread, the ARM share of loans is expected to remain relatively strong at close to 30% - little changed from last year's average. Fannie Mae's economists attribute this to high home prices, adding that it will take several years of slower home price gains and a further narrowing in fixed and adjustable rate spreads for households to significantly increase their use of fixed rate mortgages.

Meanwhile, mortgage originations are expected to drop 20% to $2.26 trillion. Contributing to the fall-off is the sharp decline anticipated for refinancing activity to 31% from 45%.

The outlook for home price growth is expected to slow from its 2005 average of 11.1%. Expectations for the degree of slowing is mixed, however, with Freddie predicting appreciation at 8.3% next year, while Fannie Mae is more conservative at 3% growth.

Considering the expected gradual slowing in the housing market, prepayment speeds are expected to be relatively stable in the first half of 2006. According to Bear Stearns' outlook for the next six months, speeds are expected to bottom in February and then trend higher as activity picks up in the spring.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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