The residential real estate sector has begun to show modest signs of recovery. Will the trend continue into 2010? PMI Mortgage Insurance Co. has provided the industry with a forecast of what to expect as we move into the new year.

According to the company’s housing and mortgage market outlook, 2009 will close with a modest increase in home sales under its belt. PMI says this will carry on into 2010 as a result of high levels of affordability, strong investor activity, and first-time buyers taking advantage of distressed sales and the renewal of the first-time homebuyer tax credit.

There may be a temporary decline in sales after the new tax credit ends in April however, PMI says, as some sales that normally would have occurred later in the year are pulled forward in order to take advantage of the tax credit.

New home sales, which have to compete with foreclosures, are projected to decline by 19.4 percent in 2009. PMI says sales should rise more strongly in 2010, as the job market finally starts to improve and credit markets function better – with existing sales climbing by 8.8 percent and new sales up by 29.2 percent.

The continued oversupply of homes on the market still weighs on house prices, although the pickup in sales has tempered this, PMI explained. The company expects median existing home prices to fall by 12.6 percent by the end of 2009, but stronger sales and reduced inventory should allow prices to be about unchanged over the course of 2010.

One of the most important unknowns for the mortgage market in 2010 is what impact the end of the Fed’s purchases of Fannie Mae and Freddie Mac debt and securities will have on mortgage rates.

The purpose of the program was to support the mortgage market in the aftermath of the financial market meltdown and the conservatorship of the GSEs, PMI explained, and by doing so, the Fed’s aid has helped to lower mortgage rates, boost home sales, and keep home prices from collapsing.

“Our expectation is that mortgage rates will climb by 25-50 basis points as the Fed ends its support”, PMI said in its report. The company says the increase will be toward the upper end of that range initially, as the market adjusts to having to provide all of the demand for GSE debt and securities.

Eventually, however, PMI expects the increase to move down to the lower end of the range “as market participants recognize the safety of these instruments.” With yields on 30-year fixed-rate mortgages (FRMs) around 4.80 percent today, that suggests an initial rise to around 5.30 percent before hitting 5.75 percent by the end of 2010, the company said.

This is likely to involve two discrete periods of increases, PMI forecasts – early in the second quarter when the Fed’s purchase program ends, and in the fourth quarter when market expectations of Fed tightening increase.

PMI projects mortgage originations in 2010 to decline by about 14 percent, to $1.73 trillion, following a rise of more than 25 percent this year stemming from a jump in refinancings.

Purchase originations should climb by 23 percent in 2010 to $865 billion as home sales continue to rise and home price declines finally end. Refinance activity, on the other hand is expected to drop by about one-third to $865 billion over the course of next year, PMI says, as mortgage rates rise.