TIPS yield curve predicting near-term disinflation

[c1ue]

Re: TIPS yield curve predicting near-term disinflation

That's only true if you default - as long as you make your payments on time the lender cannot demand repayment at will. Were mortgages structured differently in the great depression days where lenders had the right to demand payoff at will?

As I noted - in the Great Depression, lenders could 'call' a mortgage at any time. I don't know if this specific method is still possible, but the many pages embedded in a modern home loan might instead add clauses such as 'late payments' to trigger the same effect. Throw in the blurriness associated with 'refinancing' - in which I have seen clauses added specifically shifting loans from non-recourse to recourse - and it is a good question what is or is not possible these days.

The only real good news is that the large banks really don't need to bother with seizing home equity these days - capitalization requirements for the large banks is a joke and home equity is at all time lows.

In a high inflation/hyperinflation scenario however, all bets are off.

[thriftyandboringinohio]

Re: TIPS yield curve predicting near-term disinflation

As I noted - in the Great Depression, lenders could 'call' a mortgage at any time. I don't know if this specific method is still possible, but the many pages embedded in a modern home loan might instead add clauses such as 'late payments' to trigger the same effect. Throw in the blurriness associated with 'refinancing' - in which I have seen clauses added specifically shifting loans from non-recourse to recourse - and it is a good question what is or is not possible these days.

The only real good news is that the large banks really don't need to bother with seizing home equity these days - capitalization requirements for the large banks is a joke and home equity is at all time lows.

In a high inflation/hyperinflation scenario however, all bets are off.

We refinanced a few months ago, and I read every single word, looking carefully for new terms that might be onerous.
They cannot just call in my loan unless I'm badly in arrears and they've notified me of my default, all that was spelled out.
Of course that's only in my state, and at my bank, and in my particular loan. But none of that is unusual - Ohio, big bank, standard retail mortgage for a good-credit score borrower.

[raja]

Re: TIPS yield curve predicting near-term disinflation

If you want to attack the rate/price comment, it would behoove you to consider using a fixed monthly payment as a reference.

For $1000/month payment, the amount of loan that can be serviced is a bit under $210,000 at 4% and a bit under $137,000 at 8%.

The total payments made is identical in both cases ($360K paid).

Rather a significant difference than your 100K/80K 'example'.

In your example, if I choose the lower interest rate of 4%, I get a $210,000 house.
If I choose the higher interest rate of 8%, I get a $137,000 house.
In both cases, I pay the same total amount over 30 years.
So what?

The issue is whether paying a lower purchase price is better than paying a higher rate. Your example doesn't make a comparision between these two variables, so how is it pertinent?

[raja]

Re: TIPS yield curve predicting near-term disinflation

I have an idea! Let's pick two totally arbitrarily chosen figures out of the air and pretend there is a direct relationship between them!

If you don't like my numbers, create an example using numbers you prefer and prove me wrong.

I picked 4% because that's about the current rate, and 8% because that historically has been what might be considered a higher rate. I chose $100,000 for ease of figuring, and $80,000 as an example of the housing sector falling 20%, which many "experts" consider possible. But any starting purchase price, with a second number giving a 20% decline in price, will serve to prove my point.

I actually consider my higher interest rate number to be quite conservative, as I expect future rates to be much higher than 8%. But I'm certainly willing to consider an example that you think would be more useful.

[raja]

Re: TIPS yield curve predicting near-term disinflation

The point is that it is best to buy a house when the prices have bottomed - generally when the rising interest rate has stabilized at what you would perceive to be the highest level. Then, even though you are paying a higher rate, your house has a chance of appreciating and negating the higher interest rate.

I see your point.
In some scenarios, it may be correct; but geneally I think it is not.

Let's look at it in detail:

Some expect housing prices to stay low for years, and that the 5% yearly appreciation of the past will never return.
I don't know how you feel about that, but I will calculate using an "optimistic" scenario and figure a 3% appreciation.

If you pay $100,000 for a house at 4% fixed, the total cost at the end of 30 years is $171,871. At 3% appreciation, your house will be worth $242,746 after 30 years.

If you pay $80,000 for a house at 8% fixed, the total paid over 30 years is $211,326.
At 3% appreciation, your house will be worth $194,980 after 30 years.

But in the second case, you bought at the bottom of the market, so the potential for appreciation is greater. So let's say your $80,000 house appreciates at the same rate as the $100,000 house. At this higher appreciation rate, your house will be worth $242,746 after 30 years.

The difference in total cost in 30 years between the two scenarios is $39,455.
If we subtract, the $20,000 -- the difference in purchase price between the two houses -- from the $39,455 total cost, the difference is $19,455. So, given this hypothetical example, it is still better to pay a higher purchase price than pay a higher mortgage rate.

This calls into question your assertion, "even though you are paying a higher rate, your house has a chance of appreciating and negating the higher interest rate."
And, EJ is still wrong.

[c1ue]

Re: TIPS yield curve predicting near-term disinflation

In your example, if I choose the lower interest rate of 4%, I get a $210,000 house.
If I choose the higher interest rate of 8%, I get a $137,000 house.
In both cases, I pay the same total amount over 30 years.
So what?

The issue is whether paying a lower purchase price is better than paying a higher rate. Your example doesn't make a comparision between these two variables, so how is it pertinent?

The differences are many.

As you cannot seem to understand them - nor are apparently trying to - here are just a few:

1) In the case of $210,000 - you're owing the bank $73,000 more.
2) In the case of $210,000 - you're paying more property tax
3) In the case of $210,000 - additional payments have much less effect
4) In the case of $137,000 - you pay less taxes

And of course, the biggest points:

5) Neither a high asset price nor a low interest rate in reality actually helps you
6) The value of a home, if mortgages matter, is a function of interest rate. What are your risks if you buy a home with historically low interest rates?

Just admit your example was wrong as was your methodology, and move on.

[raja]

Re: TIPS yield curve predicting near-term disinflation

The differences are many.

As you cannot seem to understand them - nor are apparently trying to - here are just a few:

1) In the case of $210,000 - you're owing the bank $73,000 more.
2) In the case of $210,000 - you're paying more property tax
3) In the case of $210,000 - additional payments have much less effect
4) In the case of $137,000 - you pay less taxes

And of course, the biggest points:

5) Neither a high asset price nor a low interest rate in reality actually helps you
6) The value of a home, if mortgages matter, is a function of interest rate. What are your risks if you buy a home with historically low interest rates?

Just admit your example was wrong as was your methodology, and move on.

I'm planning on investing in some real estate, so the answer to this issue is of direct material importance to me.
I often float my investment ideas to get feedback, hoping avoid costly mistakes by getting other points of view. So far, the only criticism to my post I found worthy of deeper investigation was that of steveaustin2006 in regards property appreciation (see my response above).

As frequently happens with internet debates, I believe you and I have reached the point where little can be served by continuing. You feel certain that I am wrong, and I feel likewise about you. Readers of our exchange can make up their own minds.

However, in the event that I am simply not getting it, I will responsd to your last points . . . and give you the last word with your reply:

1) In the case of $210,000 - you're owing the bank $73,000 more.
--- You said in your previous post, "The total payments made is identical in both cases ($360K paid)."

2) In the case of $210,000 - you're paying more property tax
--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more property taxes.

3) In the case of $210,000 - additional payments have much less effect.
--- But the bottom line is the same.

4) In the case of $137,000 - you pay less taxes
--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more taxes.

5) Neither a high asset price nor a low interest rate in reality actually helps you
--- As I said, it's generally better to pay more in purchase price than to pay a higher interest rate . . . so, yes, a lower interest rate at a higher purchase price is better than the reverse, as I have shown . . . despite what EJ says.

6) The value of a home, if mortgages matter, is a function of interest rate. What are your risks if you buy a home with historically low interest rates?
--- Generally speaking, interest rates historically go up and down over time for all properties.

I will, of course, read your response, and if I feel that I am truly misunderstanding, I will admit my error. Otherwise, please take the "last word" and we'll let this discussion end there . . . . .

[c1ue]

Re: TIPS yield curve predicting near-term disinflation

1) In the case of $210,000 - you're owing the bank $73,000 more.

--- You said in your previous post, "The total payments made is identical in both cases ($360K paid)."

As you refuse to distinguish the difference between debt and payments made, then clearly we have vastly different financial viewpoints.

2) In the case of $210,000 - you're paying more property tax

--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more property taxes.

I'm not sure why this matters - given that you are paying the value of the property either way. It is like saying you prefer having $10,000 checking account vs. a $5000 one - yes, that's true, but in both cases the contents were paid for by you.

Or put another way: if your objective with the house is to live in it or rent it out, you should prefer having a lower cost basis rather than having a higher non-performing equity basis.

But then again, from 1) above, you clearly have different criteria than I do.

3) In the case of $210,000 - additional payments have much less effect.

--- But the bottom line is the same.

Uh, no. The bottom line is - you have far more flexibility with a higher interest rate but lower cost amount mortgage. You can pay off much faster, you can refinance and get more savings, etc etc etc.

4) In the case of $137,000 - you pay less taxes

--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more taxes.

Under this logic, you should build a $1 million dollar house in a $50K neighborhood. Because you own a property worth $1 million.

I personally would rather own a $100K house in a $100K neighborhood rather than owning a $5M house in a $5M neighborhood full of banksters - because they're the only ones who can afford those prices.

5) Neither a high asset price nor a low interest rate in reality actually helps you

--- As I said, it's generally better to pay more in purchase price than to pay a higher interest rate . . . so, yes, a lower interest rate at a higher purchase price is better than the reverse, as I have shown . . . despite what EJ says.

Strange, no part of the statement above supports your statement. Somehow still you think it does. Your examples were deeply flawed and completely arbitrary.

6) The value of a home, if mortgages matter, is a function of interest rate. What are your risks if you buy a home with historically low interest rates?

--- Generally speaking, interest rates historically go up and down over time for all properties.

And so once again, I fail to see how your answer supports your point.

If you're buying when interest rates are historically low, and interest rates go up and down all the time, then you are guaranteeing that you are paying a far higher purchase price (and interest on same) than you would otherwise need to.

Or in different terms, much of the equity you're "paying" for will disappear when interest rates increase.

Perhaps you should consider the term 'fictitious value' - the portion of asset valuation which is false.

Under this frame of reference, the $210,000 'value' you think you're buying is actually worth only $137,000.

Other notes:

If you have $210,000 - in the first case you have a house.
In the second case you have a house and $73,000 in cash.

No difference?

[dcarrigg]

Re: TIPS yield curve predicting near-term disinflation

I'm planning on investing in some real estate, so the answer to this issue is of direct material importance to me.
I often float my investment ideas to get feedback, hoping avoid costly mistakes by getting other points of view. So far, the only criticism to my post I found worthy of deeper investigation was that of steveaustin2006 in regards property appreciation (see my response above).

As frequently happens with internet debates, I believe you and I have reached the point where little can be served by continuing. You feel certain that I am wrong, and I feel likewise about you. Readers of our exchange can make up their own minds.

However, in the event that I am simply not getting it, I will responsd to your last points . . . and give you the last word with your reply:

1) In the case of $210,000 - you're owing the bank $73,000 more.
--- You said in your previous post, "The total payments made is identical in both cases ($360K paid)."

2) In the case of $210,000 - you're paying more property tax
--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more property taxes.

3) In the case of $210,000 - additional payments have much less effect.
--- But the bottom line is the same.

4) In the case of $137,000 - you pay less taxes
--- For the same cost, I would rather own a property worth $210,000 than $137,000, even if I had to pay more taxes.

5) Neither a high asset price nor a low interest rate in reality actually helps you
--- As I said, it's generally better to pay more in purchase price than to pay a higher interest rate . . . so, yes, a lower interest rate at a higher purchase price is better than the reverse, as I have shown . . . despite what EJ says.

6) The value of a home, if mortgages matter, is a function of interest rate. What are your risks if you buy a home with historically low interest rates?
--- Generally speaking, interest rates historically go up and down over time for all properties.

I will, of course, read your response, and if I feel that I am truly misunderstanding, I will admit my error. Otherwise, please take the "last word" and we'll let this discussion end there . . . . .

Raja,

I think that perhaps you underestimate the property tax differential.

In a relatively high market for property tax rates, say $30/$1,000 of assessed value, a difference of $100,000 in assessed value corresponds to $3,000 per year, or $250 per month.

In loans without a pre-payment penalty, one can erode principle much faster by overpaying monthly payments. The $250/mo difference could erode principal on the low-cost, high interest loan in your example above at about the rate of 2% per year, greatly reducing the final cost paid.

Furthermore, one has to worry about private mortgage insurance if one does not have sufficient down payment to avoid it. PMI will be lower on the home with a lower value in a higher interest environment if one prepays. Hitting 20% down payments becomes easier as well on the low value, high interest home. This might be the difference of another $50/mo. in our hypothetical scenario.

So yes. The amount paid to the bank is equal if the loan is taken in a static environment. But with a property tax differential, private mortgage insurance, and a mortgage without pre-payment penalties, the total amount paid by the owner could be substantially less on a low-value high interest loan when compared to a high value, low interest loan.

Even if one does not pay more than the required monthly payment, the overall cost of the home will be different.

$210,000 @ 4% interest over 30 years with 3% property taxes annually and 0.5% PMI for the first 20% of principal = approx. $550,000
In this case of the total cost, Principal is 38%, Interest is 26%, Tax is 34%, and PMI is 2%.

$137,000 @ 8% interest over 30 years with 3% property taxes annually and 0.5% PMI for the first 20% of principal = approx. $485,000
In this case of the total cost, Principal is 28%, Interest is 44%, Tax is 25%, and PMI is 2%.

Nothing will remain static, however. It is hard to play out exactly what tax or interest rates will do over 30 years. It is even more difficult to know how much money you will have to pay down principal at a rate faster than the minimum monthly requirements.

But having less outstanding principal debt does leave you more flexibility and make prepayment more effective. And there is always a better chance that interest rates will drop if you buy during a time of high interest rates and allow you to refinance and lower your total interest burden than if you buy at rock-bottom rates.

Anyways, I hope that this clears some of the confusion up.

[Chomsky]

Re: TIPS yield curve predicting near-term disinflation

If you don't like my numbers, create an example using numbers you prefer and prove me wrong.

I picked 4% because that's about the current rate, and 8% because that historically has been what might be considered a higher rate. I chose $100,000 for ease of figuring, and $80,000 as an example of the housing sector falling 20%, which many "experts" consider possible. But any starting purchase price, with a second number giving a 20% decline in price, will serve to prove my point.

I actually consider my higher interest rate number to be quite conservative, as I expect future rates to be much higher than 8%. But I'm certainly willing to consider an example that you think would be more useful.

You offered the example, it's on you to defend it, not for me to offer a better one for you.

[raja]

Re: TIPS yield curve predicting near-term disinflation

Raja,

I think that perhaps you underestimate the property tax differential.

In a relatively high market for property tax rates, say $30/$1,000 of assessed value, a difference of $100,000 in assessed value corresponds to $3,000 per year, or $250 per month.

In loans without a pre-payment penalty, one can erode principle much faster by overpaying monthly payments. The $250/mo difference could erode principal on the low-cost, high interest loan in your example above at about the rate of 2% per year, greatly reducing the final cost paid.

Furthermore, one has to worry about private mortgage insurance if one does not have sufficient down payment to avoid it. PMI will be lower on the home with a lower value in a higher interest environment if one prepays. Hitting 20% down payments becomes easier as well on the low value, high interest home. This might be the difference of another $50/mo. in our hypothetical scenario.

So yes. The amount paid to the bank is equal if the loan is taken in a static environment. But with a property tax differential, private mortgage insurance, and a mortgage without pre-payment penalties, the total amount paid by the owner could be substantially less on a low-value high interest loan when compared to a high value, low interest loan.

Even if one does not pay more than the required monthly payment, the overall cost of the home will be different.

$210,000 @ 4% interest over 30 years with 3% property taxes annually and 0.5% PMI for the first 20% of principal = approx. $550,000
In this case of the total cost, Principal is 38%, Interest is 26%, Tax is 34%, and PMI is 2%.

$137,000 @ 8% interest over 30 years with 3% property taxes annually and 0.5% PMI for the first 20% of principal = approx. $485,000
In this case of the total cost, Principal is 28%, Interest is 44%, Tax is 25%, and PMI is 2%.

Nothing will remain static, however. It is hard to play out exactly what tax or interest rates will do over 30 years. It is even more difficult to know how much money you will have to pay down principal at a rate faster than the minimum monthly requirements.

But having less outstanding principal debt does leave you more flexibility and make prepayment more effective. And there is always a better chance that interest rates will drop if you buy during a time of high interest rates and allow you to refinance and lower your total interest burden than if you buy at rock-bottom rates.

Anyways, I hope that this clears some of the confusion up.

The jist of what you said, "The amount paid to the bank is equal if the loan is taken in a static environment. But with a property tax differential, private mortgage insurance, and a mortgage without pre-payment penalties, the total amount paid by the owner could be substantially less on a low-value high interest loan when compared to a high value, low interest loan."

Would you then concede that in the case of . . .

1. A low property tax local,

2. For a person that doesn't need private mortgage insurance,

3. For someone who is arbitraging interest rates to beat inflation and doesn't want to pay off the loan quickly,

. . . it is better to pay a lower rate for a higher priced house than the reverse, as I originally stated?

[raja]

Re: TIPS yield curve predicting near-term disinflation

You offered the example, it's on you to defend it, not for me to offer a better one for you.

When you criticize someone for offering a poor example, it implies either that there is either a better example, or there is no good example. If the latter case is true, that means that EJ's assertion is indefensible.

Of course, there is no requirement for you to come up with a better example, but by not doing so it makes your criticism of my reasoning appear groundless . . . .

[dcarrigg]

Re: TIPS yield curve predicting near-term disinflation

The jist of what you said, "The amount paid to the bank is equal if the loan is taken in a static environment. But with a property tax differential, private mortgage insurance, and a mortgage without pre-payment penalties, the total amount paid by the owner could be substantially less on a low-value high interest loan when compared to a high value, low interest loan."

Would you then concede that in the case of . . .

1. A low property tax local,

2. For a person that doesn't need private mortgage insurance,

3. For someone who is arbitraging interest rates to beat inflation and doesn't want to pay off the loan quickly,

. . . it is better to pay a lower rate for a higher priced house than the reverse, as I originally stated?

It is perhaps better if:

1) Local property tax is less than 1%

2) PMI is no necessity

3) Payments for a home come directly from investment funds that earn at least 1% greater after fees than the standard treasury rate.

But it still leaves one in a more precarious position than the other way around. And If home prices drop, you're in a bad, bad spot.

All the same, there will be individual cases where it is more than worthwhile.

There will be cases where a stockowner makes out as the market collapses without a hedge.

Thus is life.

[raja]

Re: TIPS yield curve predicting near-term disinflation

It is perhaps better if:

1) Local property tax is less than 1%

2) PMI is no necessity

3) Payments for a home come directly from investment funds that earn at least 1% greater after fees than the standard treasury rate.

But it still leaves one in a more precarious position than the other way around. And If home prices drop, you're in a bad, bad spot.

All the same, there will be individual cases where it is more than worthwhile.

There will be cases where a stockowner makes out as the market collapses without a hedge.

Thus is life.

O.K. Let's go with with the average U.S. property tax rate of 2.5%.
And let's use my example (until somebody comes up with a better one).
I've boosted the purchase prices to $200,000 and $160,000 to make it more realistic.

$200,000 home at 4% = Purchase price + interest over 30 years is $343,739. Property tax at 2.5% = $5,000/year or $150,000 over 30 years. Total cost = $493,739.

$160,000 home (20% less) at 8% = Purchase price + interest over 30 years is $422,652. Property tax at 2.5% = $4,000/year or $120,000 over 30 years. Total cost = $542,652.

Thus, using my example -- even with a differential in property tax -- there is $48,913 more profit when paying more in purchase price at a lower rate, than paying less at a higher rate. EJ is wrong.

Sure, you can set up scenarios in which the reverse is true, I grant you. Now, if you want to do the research to determine how many property buyers use mortgage insurance, or how many pay their mortgage with investments producing return rates less than 1%, be my guest. Then, we will know statistically just how wrong EJ's position is. But the fact is that, on the bare bones of it without any added qualifiers, I am right . . . EJ is not.

I'm going to bow out of this thread now, as I don't want to be perceived as harping on the issue. However, I will read any additional posts by members . . . .

[c1ue]

Re: TIPS yield curve predicting near-term disinflation

Thus, using my example -- even with a differential in property tax -- there is $48,913 more profit when paying more in purchase price at a lower rate, than paying less at a higher rate. EJ is wrong.

I do find it amusing that somehow your paying $48,913 is somehow construed as your additional profit.

There is additional profit, but it isn't yours.

Even your example - you're cheating again. The actual difference between a $200,000 price at 4% vs. the price at 8% interest rates is not $40,000 - it is over $70,000.

If you persist in arbitrarily choosing numbers to confirm your own bias, then of course you're always going to be 'right'.

The actual difference between correctly equalized prices is far larger, and in a far different direction, than your false numbers.

The correct difference would be: $343k in both cases for the loan representing identical ability to pay, but property taxes on the $200K price would be $150K and on the other property would be $101K - which is 100% opposite to what you created.