Last week the Mortgage Bankers Association (MBA) Purchase Index rose 15% and came in at 500.9, a level that is rarely seen. To give some idea of the rarity, last Jan. 16, the index hit 502 - the only time in recent history that the index had risen above 500. Meanwhile, the Refinance Index also increased by 27.6%.

"This was a surprisingly strong purchase reading, given the holiday-shortened week," said analysts from JPMorgan Securities. They stated that the Purchase Index is a more meaningful number in the current market environment because it adds more support to the belief that turnover activity will stay at record levels in the summer months.

In recent research, RBC Dain Rauscher Vice President Kevin Jackson said, "A combination of fence sitters' and a robust housing market has continued to make real estate attractive and mortgage activity robust."

He noted that mortgage rates have stayed at less than 6.5% since July 2002. He also cited other factors, such as home prices continuing to increase across the U.S. and building activity remaining quite robust throughout the summer.

Jackson said that turnover activity (specifically on discounts) will be higher compared to 1994 and 1998, citing several factors. For one, home prices have increased steadily since 1996. Home prices in the New England region, for example, have risen 70% in the past five years. Home equity and borrower mobility rates are also at their peak levels. Moreover, the Purchase Index increased by 137% this year while it remained unchanged between January 1994 and December 1994.

In this light, Jackson recommends slightly seasoned discounts - 2003 production 5.0% and 5.5%. He also likes 100% California, Massachusetts and New England region MBS, plus discount 3/1, 5/1, and 7/1 hybrid ARMs (conforming and nonconforming), par priced GNMA 1/1 ARMs, discount PACs off slightly seasoned collateral and seasoned relocation loans.

Art Frank, head of mortgage research at Nomura Securities International, said that rates have gone up enough to hinder refinancing activity but are not up enough to curtail purchases. Also, hybrid ARMs are gaining market share versus fixed-rate loans.

In his mid-year commentary, Frank said that there are three reasons why he believes housing turnover this year and next will be 40% to 50% faster compared to the 1994 to 1995 period. He pointed out that 1993 6s had prepaid slightly over 2% CPR in the fourth quarter of 1994; 50% faster means 2003 production 4.5s should prepay slightly over 3% CPR in a bear market.

The housing market was much stronger in 2000 to 2004 versus 1990 to 1994, said Frank. This is why the average mortgagor today has more equity compared to 1994. Since homeowner equity is associated with the propensity to move, this suggests higher housing turnover.

Aside from this development, the Taxpayer Relief Act - which was passed in August 1997 - changed the capital gains tax treatment for primary residences. Since August 1997, married couples filing jointly can exclude up to $500,000 of capital gains on the sale of their primary residence from capital gains taxation, without moving up to a larger house as long as the house was their primary residence for at least two years. This provision has freed many empty nesters from being locked into large suburban homes to avoid capital gains taxes, and has thus raised housing turnover by 10% to 20%.

He also noted the current availability of a range of hybrid ARM alternatives in high-rate environments. This means mortgagors with discount fixed-rate loans are less locked into those mortgages compared to 1994 to 1995, when the hybrid ARM market was just beginning.

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