With housing market weakness, analysts are starting to examine how rising interest rates could further weaken the borrowers' ability to afford their homes.

In their weekly report, Countrywide Securities analysts noted that the increase in interest rates over the past three months have pushed affordability back to stressed levels. So they looked at various scenarios regarding affordability and housing demand to calculate the length of time for affordability to improve and allow the housing market to return to a more normal level.

Countrywide used its CSC Affordability Index and input interest rates, incomes, home prices and borrower product choice. In the base case, for example, the analysts assumed current rate levels, no change in home prices in year one or subsequent years, a 3% increase in incomes in the first year and in subsequent years, and Countrywide's June 2007 product mix. In this case, it would take until the second quarter of 2011 for the firm's index to move to a more normal housing market. A scenario in which the Federal Reserve cuts interest rates 50 basis points, resulting in lower mortgage rates, the same 0% change in house prices and a 3% increase in incomes, suggested a return to a more normal housing market by the 4Q09. A larger Federal Reserve cut reduced the time even further, while a scenario of a mild bear steepener with the Federal Reserve hiking rates 25 basis points and 30-year mortgage rates higher by 60 basis points pushed the recovery in affordability out to 2013.

Analysts concluded that the latest increases in interest rates have made it more difficult to see a quick recovery in housing. "Unless rates fall quickly, further price weakness is likely," analysts said. On the bright side, they expect the adjustment in activity and home prices will be orderly and relatively shallow, although they noted that, "further weakness in housing could seriously weaken prospects for economic growth." Their view of the most realistic outlook-a combination of modest declines in interest rates and home prices, along with a steeper yield curve-could set the stage for a recovery in housing beginning in late 2008 or early 2009.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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