Mortgage Rates- Confounding the Sheeple

[don]

Keep 'em rollin, rollin, rollin, though their disapproven, keep them sheeple movin', rawhide.....

Give me a high interest rate and a low priced home over a record low interest rate and a home with an inflated price any time.

It is hard to say how many understand this concept and why this is so important. When I bring this up to potential buyers they just do not understand why this would make financial sense. It seems counter-intuitive in a world driven by interest rates. For these potential buyers the interest rate is merely a method of squeezing out the maximum monthly payment from their strained income. (the mortgage interest deduction allowance is another misunderstood "benefit" to homeowners, to be taken up at another time)

People forget that in 1981 the 30 year fixed mortgage rate peaked at over 18 percent. Today while many talk about “rising” interest rates the 30 year fixed is still hovering around 5 percent. The four decade average is closer to 9 percent but the Federal Reserve has meddled to keep the lid on interest rates low for the time being. The only reason the Federal Reserve is following this path is because it needs to keep home values inflated or face another deep banking correction. Keeping rates low allows Americans to purchase as much home as possible with maximum face value while allowing banks to keep the pretend game going regarding real estate values. This is a bad move for potential buyers and we will examine why.





Over the last 10 years interest rates have gone from 8.21 percent on January of 2000 to the current 4.71 percent. The 30 year fixed mortgage was like trying to bring a Beach Boys CD to a swank Hollywood club. However today the 30 year fixed mortgage does matter because it is biggest game in town. To demonstrate how big of a difference these various rates are let us run four scenarios: the peak 1981 rate, the historical average 9 percent, the January 2000 rate of 8.21, and the current rate. We’ll run the numbers for the median priced California home of $256,000:

Keep in mind the above does not include insurance and taxes. Why is the above important? First, it highlights how stretched many home buyers have become merely to purchase a home even after the substantial correction. A large reason for this has been the lost wages for many and stagnant income growth for most middle class families.

A lowering of the interest rate gives a perceived feeling that people have more buying power because in a way they do.

This is Federal Reserve alchemy. It comes at a large cost of bailouts, Quantitative Easing, and a general bubble environment where hot money chases whatever is the flavor of the day. Ultimately a low interest rate gives the potential buyer a very expensive asset that seems inexpensive because of an artificially low interest rate. Just look at the historical average of 9 percent. If the 30 year fixed mortgage reaches this level a typical buyer will need to pay a stunning 54 percent more each month on principal and interest. Is this even doable in this economy with virtually no wage growth? Of course this is not a sustainable path and that is why we are seeing home prices come down since mortgage rates are scraping the bottom of the barrel.

A lost decade is already seen in Southern California mortgage payments:


Source: DataQuick


For all the talk about hot money flowing into Southern California and giant bank accounts the typical mortgage payment stood at $1,136 for the latest month. This is where the “hot” money is since families now have to document income and go with 30 year fixed mortgage products. When the bubble burst it exposed the inflated asset values but it also unraveled an entire decade of lost income covered with the trappings of a debt lifestyle.

What we had for the large part of the decade an entire mortgage market that cared not about documented income but about a willingness to buy into the cult-like mentality that somehow real estate values never went down. It was a hot money bubble.

A lower priced home is much more valuable than a low interest rate. As a buyer you're paying off more of the house and less to the bank. It also provides you a variety of options:

-You can pay down the debt quicker with extra payments. Since you paid less, each extra dollar you send will eat away the principal quicker. Believe it or not mortgage burning parties did exist.

-Flexibility. If rates are high, it is likely they will stay that way or move lower. If they move lower, future potential buyers have more flexibility in buying your home so the pool of buyers increases. Today is as low as we go.

-Price. People seem to have forgotten that value comes from price, not the interest rate. The banking industry has made a living off economic rents and interest rates have become so crucial that our central bank is now obsessed with keeping rates low only to keep housing values inflated.

The market is demanding a higher interest rate. Only artificial intervention is keeping the rate low. How long can this go on? We’ve already passed the $14 trillion mark with national debt and it is likely our Congress will need to raise the debt ceiling yet again. And for what? To keep housing values inflated while Americans struggle to find work? To keep rates low so banks can chase easy money around the globe and inflate the stock market? The entire economy is being held together with the duct tape that is known as Federal Reserve sponsored low interest.

http://www.doctorhousingbubble.com/i...-rates-decade/

[Munger]

Re: Mortgage Rates- Confounding the Sheeple

Two problems.

(1) When is the Federal Reserve going to raise the interest rate, and how high will it go?

My guess -- not for a long time and not much. It just can't. Look at Japan. This being the case, prices won't be affected by rising interest rates for a decade or more (if ever).

(2) Despite the intuitive appeal of this reasoning, there seems to be little correlation between interest rates and house prices.

Link 1, link 2.

[karim0028]

Re: Mortgage Rates- Confounding the Sheeple

Two problems.

(1) When is the Federal Reserve going to raise the interest rate, and how high will it go?

My guess -- not for a long time and not much. It just can't. Look at Japan. This being the case, prices won't be affected by rising interest rates for a decade or more (if ever).

(2) Despite the intuitive appeal of this reasoning, there seems to be little correlation between interest rates and house prices.

Link 1, link 2.

1) High interest rates will at best be a headwind and at worst a complete flattening of the market. You might not get a collapse in the market in nominal terms but it will not come out well in inflation adjusted terms

2) Folks buy a houses the same way they lease their cars; based on payment... High prices and high interest rates mean you have to come up with a big chunk down... I dont think the average joe has that much in savings....

3) In the 80's you didnt have a MASSIVE housing bubble that wiped out 30-40% of current home owner equity and led to many becoming debt serfs..... That memory will not be easily forgotten. Bubbles that burst dont come back for quite a while...... A smart investor can make a killing, a happy go lucky home buyer with no understanding of business will likely get a liability that he will lose money on for years to come.

3) Interest rates might stay low, but interest rates are markets just like stocks and housing and at minimum they will revert to the mean..... It seems that folks keep saying the FED wont let rates go up; sounds kind of like dot com and housing talk to me..... NOTHING stays in an imbalanced state forever... The FED might have no hand in it.... Its not incalculable that they could lose control; this is a human system its not perfect.

[c1ue]

Re: Mortgage Rates- Confounding the Sheeple

(1) When is the Federal Reserve going to raise the interest rate, and how high will it go?

My guess -- not for a long time and not much. It just can't. Look at Japan. This being the case, prices won't be affected by rising interest rates for a decade or more (if ever).

(2) Despite the intuitive appeal of this reasoning, there seems to be little correlation between interest rates and house prices.

This is typical disingenuous crap.

There is this little detail missing: housing price to income ratios

The ratio in the '80s was slightly above 4 to 1 (average housing price vs. average income) with an average absolute delta of $67K and with incomes rising

The ratio today is over 5 to 1 with the average absolute delta of $180K+ and with incomes falling

As for the assertion that cheap money doesn't increase price paid - again complete horsepuckey.

Or did we learn absolutely nothing from the just departing housing bubble?

Is not the definition of NINJA loans the ultimate in cheap money? And did these NINJA borrowers in fact overpay both in interest rates, price, and every other metric you can name?

To use a single example of a single borrower in a sea of cash buyers is a complete snow job.

Very few buyers of homes in fact pay cash or else there would be a hell of a lot more homes fully paid off than the 1/3 that have.

Similarly if the majority of home buyers paid cash in some significant fraction much less in toto, then equally so there would not be 30% or more of all mortgages, which equals 20% of ALL homes period, which are negative equity.

[don]

Re: Mortgage Rates- Confounding the Sheeple

When the feds cooked up the latest housing prop, the tax credit for "new" home buyers, the amount was immediately doubled and added to the price of listed homes. What could be more recent and concrete an example than that. It is ingenious how the masses self-interest is entwined with FIRE. No tax deduction on mortgage interest would not lower housing prices- it would cut out the added fat that it makes possible. The net effect would be the listed pricing would fall back to where they should be. FIRE would raise interest rates, lapping up the difference dictated by the monthly payment nut. Where sheeple interests come in is that existing homeowners would feel the loss of equity, ergo they would fight for FIRE.

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

Keep 'em rollin, rollin, rollin, though their disapproven, keep them sheeple movin', rawhide.....

Baaaa!

(From Dr. Housing Bubble): We’ve already passed the $14 trillion mark with national debt and it is likely our Congress will need to raise the debt ceiling yet again. And for what? To keep housing values inflated while Americans struggle to find work?

Is this a non-sequitur? He seems to be complaining about the Federal Reserve -- that should be currency debasement argument, not so much a national debt argument. Maybe he means the Treasury's backing of the GSEs?

[zoog]

Re: Mortgage Rates- Confounding the Sheeple

Some historical notes to compare to today:

Prior to the 1930's, US home mortgages were only 5- to 10-year loans, variable interest rate, required 50 percent or more downpayment, and a balloon payment at the end of the term for any remaining principal. Imagine trying to buy a house today under those conditions.

During the Great Depression, the foreclosure rate was as high as 10%. Lately it has been around 2%. Part of the New Deal included creating the Home Owner's Loan Corporation and the Federal Housing Administration. The HOLC purchased about one million defaulted mortgages and converted them into 20-year fixed-rate fully amortizing mortgages. The FHA provided mortgage insurance to convince private investors to purchase the mortgages. The HOLC only operated for a few years, then it was effectively replaced by the Federal National Mortgage Association (aka Fannie Mae).

In 1948, the FHA extended mortgages to 30 years and raised the loan-to-value ratio from 80 to 95 percent for new homes and 90 percent for existing. Private mortgage insurance began to compete with the FHA in the 1950's.

Mortgage rates remained around 5 to 6 percent while Treasury bonds paid no more than 4 percent. As inflation volatility increased in the 1960's and 1970's, Treasury securities rose; additionally, the growth of money market funds, mutual funds, and pensions attracted savings away from depository institutions.

This led to a significant move away from depository lenders holding onto fixed-rate mortgages and instead passing them through Fannie Mae, Freddie Mac, and Ginnie Mae to be packaged and sold as mortgage-backed securities. Variable-rate mortgages also made a comeback as buyers were reluctant to commit to double-digit fixed rates.

In 1949, US mortgage debt was 20 percent of total household income and 15 percent of household assets. In 1979 it was 46 percent and 28 percent. In 2001, 73 percent and 41 percent.

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

Baaaa!

Here's a calculation I made recently.

Scenario #1: Buy house during generational low in mortgage interest rates, but pay higher real price than likely low point. Put 20% down and get a fixed 3.875% rate for 30 years.

Scenario #2: Hypothetically, wait a few years -- fixed 30-year mortgage rates are now 9% and the house price is 40% below Scenario #1, such that a buyer putting 20% down will have the same monthly payment as in Scenario #1. However, I have managed to preserve the purchasing power of my down payment funds, so I can put 33% down rather than 20% down, due to the reduction in house price.

An amortization calculator says that I will pay 16% more over 30 years in Scenario #1 as opposed to Scenario #2, for the specific property I was analyzing.

The above calculation is imperfect, but it helped to quantify some of the qualitative arguments made by Dr. Housing Bubble.

[don]

Re: Mortgage Rates- Confounding the Sheeple

A friend of mine who sells real estate, when he can (he's working at my supermarket now), wondered how much house pricing would fall with no tax deduction. Here's some rough back-of-the-envelope figures. I'm sure there's iTulipers that can do this better.

Per $100,000 borrowed, at current 5% interest, that's a monthly eligible payment of $650, inc property taxes. At a 25% tax bracket, $150/month is "saved".

Take away the FIRE tariff, and the asking price would be a drop to $80,000 per $100k, $80,000 @ 5% being just over $500 a month paid.

Sound about right? And if so, as a buyer, which do you prefer? As an owner? As an owner who has lost most of their equity already?

Expect major changes in US housing if the present conditions continue.

[don]

Re: Mortgage Rates- Confounding the Sheeple

Ash - Mine's the front end look and yours is the load

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

A friend of mine who sells real estate, when he can (he's working at my supermarket now), wondered how much house pricing would fall with no tax deduction. Here's some rough back-of-the-envelope figures. I'm sure there's iTulipers that can do this better.

Per $100,000 borrowed, at current 5% interest, that's a monthly eligible payment of $650, inc property taxes. At a 25% tax bracket, $150/month is "saved".

Take away the FIRE tariff, and the asking price would be a drop of $80,000 per $100k, $80,000 @ 5% being just over $500 a month paid.

Sound about right? And if so, as a buyer, which do you prefer? As an owner? As an owner who has lost most of their equity already?

Expect major changes in US housing if the present conditions continue.

I get about the same number.

Initially, interest payments at 5% are around $400/mo per $100k borrowed (well, starts at $416.67 and falls to about $411 at the end of the first year), so I presume the $650 figure factors in $150 in monthly property taxes ($1800/yr per $100k). That property tax figure per $100k seems way high to me, but I'm sure it depends upon where you live.

So, assuming a 25% tax bracket, the mortgage interest deduction would make a ~$150/mo ($162.5) difference to a buyer.

If the buyer's spending power is reduced by $150/mo per $100k borrowed, then at 5%, the impact ought to be that without the mortgage interest rate deduction, they borrow $72k where they would have borrowed $100k. In other words, the full P&I on $72k at 5% is equal to the P&I on $100k at 5%, less $150 a month. In both scenarios, the buyer coughs up about $386 net per month.

So, it seems to me that the buyer is going to be able to borrow 72% of what they otherwise would with the mortgage interest rate deduction, so home prices should drop about 28%. That's close to the figure you cited.

Yeah. If the mortgage interest rate deduction is axed, as in some of the tax reform proposals, that will be a huge deal. Knowing how close to the edge some families live, I have wondered whether Congress could actually make this one fly (unless it is undertaken really slowly). I've also wondered about the combination of higher mortgage interest rates AND reduced/eliminated mortgage interest rate deduction.

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

Ash - Mine's the front end look and yours is the load

It does seem that if one believes mortgage rates will return to the 8-9% level, and that home prices will have to respond based upon the income available for payments, Dr. Housing Bubble is right about optimal buying conditions. (No surprise there, given that this has been a theme around iTulip for some time.) I'll just focus on what I'm buying for my 16% premium, and hope it doesn't turn out to be a 160% premium in the end.

[llanlad2]

Re: Mortgage Rates- Confounding the Sheeple

Here's a calculation I made recently.

Scenario #1: Buy house during generational low in mortgage interest rates, but pay higher real price than likely low point. Put 20% down and get a fixed 3.875% rate for 30 years.

Scenario #2: Hypothetically, wait a few years -- fixed 30-year mortgage rates are now 9% and the house price is 40% below Scenario #1, such that a buyer putting 20% down will have the same monthly payment as in Scenario #1. However, I have managed to preserve the purchasing power of my down payment funds, so I can put 33% down rather than 20% down, due to the reduction in house price.

An amortization calculator says that I will pay 16% more over 30 years in Scenario #1 as opposed to Scenario #2, for the specific property I was analyzing.

The above calculation is imperfect, but it helped to quantify some of the qualitative arguments made by Dr. Housing Bubble.

If you wait too long and wage inflation kicks in then the house price will never drop 40%. From 1970-1980 in the UK during the great inflation house prices went from £5000 to £20000 despite high interest rates as wage inflation ran high enough to make up for increased payments.
If the same happens again getting a long fix with minimum down payment now might be the way to go.

[gwynedd1]

Re: Mortgage Rates- Confounding the Sheeple

I have made this observation as well. One has little reward for paying off a mortgage early with low interest rates while also buying into an inflated property value. Real Estate values are very much influenced on debt carrying capacity.

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

Two problems.

(1) When is the Federal Reserve going to raise the interest rate, and how high will it go?

My guess -- not for a long time and not much. It just can't. Look at Japan. This being the case, prices won't be affected by rising interest rates for a decade or more (if ever).

(2) Despite the intuitive appeal of this reasoning, there seems to be little correlation between interest rates and house prices.

Link 1, link 2.

Munger -- I don't know why folks around here are so hostile to your posts -- for my money, you're one of the brightest and most thoughtful people on the forum. Notably, you don't subscribe to many of the 'givens' shared by many in the iTulip crowd, but that keeps this forum from being a total echo chamber. Thanks for sticking around.

(1) It is my impression that 30-year mortgage rates are tied more closely to the 10-year Treasury rate than to the federal funds rate. So, it seems to me that mortgage rates and the federal funds rate might rise at the same time in an inflationary environment, but that both would be responding to inflation rather than each other. In some respects, this is still the same question -- when will high inflation compel lenders to charge higher interest rates, and the Fed to withdraw liquidity? If we don't have a dollar crisis, then it could indeed be a long way off. If we do have a dollar crisis, then it could happen rapidly.

(2) One presumes that house prices reflect what buyers are able to pay. My impression is that we're coming off of one extreme of mortgage underwriting and buyer leverage, so that factors which could have offset the impact of higher interest rates in prior years will not come into play going forward. But that's just my guess.