Middle class homebuyers taking $7k mortgages planning to later refinance down(fortune.com)
fortune.com
Middle class homebuyers taking $7k mortgages planning to later refinance down
https://fortune.com/2023/07/19/mortgage-rates-housing-market-affordability-borrower-refinance-speculation/
85 comments
https://archive.is/12r9Z
This was actually a very nice article! Thanks!
I liked the last line the most .. I think we've all gotten accustomed to zero interests, and this has changed our behavior. My father to a large extend screwed up his (and our family's) life because he lived in an era of high rates. He did not understand the world had changed. We could have bought a house for cash in 1995 but he chose to rent. After that, it was always a bubble, with no buying opportunity like 1995 ever.
It makes me wonder if all of us have similarly not realized the world is a different place post rate hikes. There is this inevitable dogma that "rates will go back down". A lot of people are making that bet and I wonder if it is just history again.
What I don't understand is what is driving the US economy today. It seems to be firing on all if not most cylinders. People I know who got laid off are finding work (I hear negative experiences too and feel for those people). Hiring in tech seems like it is picking up.
I liked the last line the most .. I think we've all gotten accustomed to zero interests, and this has changed our behavior. My father to a large extend screwed up his (and our family's) life because he lived in an era of high rates. He did not understand the world had changed. We could have bought a house for cash in 1995 but he chose to rent. After that, it was always a bubble, with no buying opportunity like 1995 ever.
It makes me wonder if all of us have similarly not realized the world is a different place post rate hikes. There is this inevitable dogma that "rates will go back down". A lot of people are making that bet and I wonder if it is just history again.
What I don't understand is what is driving the US economy today. It seems to be firing on all if not most cylinders. People I know who got laid off are finding work (I hear negative experiences too and feel for those people). Hiring in tech seems like it is picking up.
What do you mean by “screwed up”?
I find the US mortgage market deeply weird.
I’ve had mortgages in two countries, the UK and Australia. They work very similarly, you can generally get a ‘tracker’ mortgage, which is a little above the central bank rate and tracks the central bank rate, so your repayments vary over time, or you can get a fixed rate.
Fixed rates are usually more expensive, and the longer you fix (typically 1,2,3 or 5 years, though you do see 8) the more of a premium you pay over the tracker rate. When your fixed period expires you usually refinance based around whatever new rates are available at that point, and you are usually constrained from refinancing during that period (exit fees).
But in the US I understand that people usually fix the rate for the whole term of the loan? And I imagine that makes refinancing quite rare?
Is this not quite risky for banks? Not that banks taking a risk is bad, but it seems a very long bet for them.
What sort of interest rate premium over the base rate is common?
In the UK or here AFAICT it’s usually about 1.2-1.5% over base rate for the better value trackers and goes up from there for fixed, depending on your loan to value ratio as well. IIRC I had a five year fixed at about 2.5% over base in the UK, though memory is fuzzy.
I’ve had mortgages in two countries, the UK and Australia. They work very similarly, you can generally get a ‘tracker’ mortgage, which is a little above the central bank rate and tracks the central bank rate, so your repayments vary over time, or you can get a fixed rate.
Fixed rates are usually more expensive, and the longer you fix (typically 1,2,3 or 5 years, though you do see 8) the more of a premium you pay over the tracker rate. When your fixed period expires you usually refinance based around whatever new rates are available at that point, and you are usually constrained from refinancing during that period (exit fees).
But in the US I understand that people usually fix the rate for the whole term of the loan? And I imagine that makes refinancing quite rare?
Is this not quite risky for banks? Not that banks taking a risk is bad, but it seems a very long bet for them.
What sort of interest rate premium over the base rate is common?
In the UK or here AFAICT it’s usually about 1.2-1.5% over base rate for the better value trackers and goes up from there for fixed, depending on your loan to value ratio as well. IIRC I had a five year fixed at about 2.5% over base in the UK, though memory is fuzzy.
The US and Denmark are the two well known jurisdictions with fixed rates for the loan term (typically 30 years in the US).
Refinancing happens when rates go down.
Yes, this does mean lenders take a lot of interest rate risk. The whole US government mortgage securitization and insurance infrastructure exists to help transfer this risk to people who want it.
More in this classic Byrne Hobart essay: https://byrnehobart.medium.com/the-30-year-mortgage-is-an-in...
Refinancing happens when rates go down.
Yes, this does mean lenders take a lot of interest rate risk. The whole US government mortgage securitization and insurance infrastructure exists to help transfer this risk to people who want it.
More in this classic Byrne Hobart essay: https://byrnehobart.medium.com/the-30-year-mortgage-is-an-in...
> transfer this risk to people who want it.
One party that evidently wants it is the Federal Reserve. Ever since the GFC, they've been holding about half the stock:
https://fred.stlouisfed.org/graph/?g=17fFi
One party that evidently wants it is the Federal Reserve. Ever since the GFC, they've been holding about half the stock:
https://fred.stlouisfed.org/graph/?g=17fFi
I find the non-US model weird... What are you supposed to do if 3 years into owning a house the rate goes way up? At that point you will have almost no equity and extending the term isn't going to help much.
People actually do refinance frequently if rates go down. If they go up naturally they'll keep their lower rate.
This does create issues when rates go up a lot like they just did, because it makes it harder for people to move.
Fixed rate mortgages do create risk for banks, and some banks have run into trouble recently, although a lot of mortgages are resold by banks and packaged into bonds, either by investment banks or by the "Government Sponsored Entities", Fannie Mae and Freddie Mac.
People actually do refinance frequently if rates go down. If they go up naturally they'll keep their lower rate.
This does create issues when rates go up a lot like they just did, because it makes it harder for people to move.
Fixed rate mortgages do create risk for banks, and some banks have run into trouble recently, although a lot of mortgages are resold by banks and packaged into bonds, either by investment banks or by the "Government Sponsored Entities", Fannie Mae and Freddie Mac.
You’re supposed to be able to afford it if the rate goes up, and build that into your risk model, and rein in your spending.
This then means that central bank interest rises have an immediate effect on the spare cash for a wide swathe of the population.
You’re also supposed to have at least 20% equity at the get-go in Australia, or you end up having to pay extra for some sort of loss of value insurance (I haven’t looked into this much as it’s not my situation). This is making it hard for young folks to get started in an environment of elevated prices.
From my perspective it would be a pretty sweet deal if I could fix my loan for 25 years and only ever revise the rate down!
That’s why I was asking - what sort of rates do you actually end up paying, vs the central bank rate at the time?
This then means that central bank interest rises have an immediate effect on the spare cash for a wide swathe of the population.
You’re also supposed to have at least 20% equity at the get-go in Australia, or you end up having to pay extra for some sort of loss of value insurance (I haven’t looked into this much as it’s not my situation). This is making it hard for young folks to get started in an environment of elevated prices.
From my perspective it would be a pretty sweet deal if I could fix my loan for 25 years and only ever revise the rate down!
That’s why I was asking - what sort of rates do you actually end up paying, vs the central bank rate at the time?
Here in Australia, the regulator requires banks to assess your ability to make repayments at an interest rate three percentage points higher than the actual rate. A few years ago it was a floor of 7% rather than a buffer, and they'll probably go back to something like a 2% buffer and a 7% floor (rates increased by more than 3 percentage points in recent times, so looks like a three percent buffer alone isn't enough).
But yeah, mostly what happens if rates go up is that you begrudgingly pay it, because most in that situation can afford it (those who have changed circumstances may not be able to, but most can).
Edit: also, the fact that mortgage holders are more sensitive to rate increases means (it is thought that) the central bank doesn't need to change rates by as much to get the same effect. If there would be widespread mortgage defaults given a certain sized rate increase, then that probably means the central bank can stop short of an increase that large.
So the problem is sort of self-limiting. Rate hikes are designed to induce financial strain, but too much isn't desirable, so central banks don't hike too much on purpose (they sometimes do by accident).
But yeah, mostly what happens if rates go up is that you begrudgingly pay it, because most in that situation can afford it (those who have changed circumstances may not be able to, but most can).
Edit: also, the fact that mortgage holders are more sensitive to rate increases means (it is thought that) the central bank doesn't need to change rates by as much to get the same effect. If there would be widespread mortgage defaults given a certain sized rate increase, then that probably means the central bank can stop short of an increase that large.
So the problem is sort of self-limiting. Rate hikes are designed to induce financial strain, but too much isn't desirable, so central banks don't hike too much on purpose (they sometimes do by accident).
> Is this not quite risky for banks? Not that banks taking a risk is bad, but it seems a very long bet for them.
It is and it isn’t I think. They rebundle those into securities and sell them on so that other banks and investment firms convert capital into cash flow and it acts like an investment portfolio (then others leverage those securities with derivatives). So the bank isn’t holding the loan directly typically. Of course, as we found out in 2008, the amount of exposure to risk is generally poorly understood even by the players. That being said, I believe similar things happen abroad, so I’m not so sure why 30 year fixed exists in America as an anomaly that you don’t see in other countries and what specific regulation / law encourages it to be this way.
It is and it isn’t I think. They rebundle those into securities and sell them on so that other banks and investment firms convert capital into cash flow and it acts like an investment portfolio (then others leverage those securities with derivatives). So the bank isn’t holding the loan directly typically. Of course, as we found out in 2008, the amount of exposure to risk is generally poorly understood even by the players. That being said, I believe similar things happen abroad, so I’m not so sure why 30 year fixed exists in America as an anomaly that you don’t see in other countries and what specific regulation / law encourages it to be this way.
I have no knowledge of Australia or the uk mortgage markets but in America mortgages get packaged up in securities and sold to investors in the market or big agencies/government programs. Most banks don’t hold mortgages on their books for long before selling them off. Some banks retain servicing but don’t hold the debt on their books. It’s all very complicated and feels like a shell game but mortgage markets have only blown up once in memory whereas I’ve stopped counting recessions.
https://en.m.wikipedia.org/wiki/Mortgage-backed_security
https://www.axios.com/2023/04/08/banks-retreating-mortgage-m...
https://en.m.wikipedia.org/wiki/Mortgage-backed_security
https://www.axios.com/2023/04/08/banks-retreating-mortgage-m...
This 2008 article in Wired does a good job of explaining how aggregation, in theory, enables bundled mortgages to create a 1+1=3 situation:
https://www.wired.com/2009/02/wp-quant/
Except the model was flawed and carried much higher tail risks. Risks that the ratings agencies failed to catch when they gave them AAA ratings in the debt market.
https://www.wired.com/2009/02/wp-quant/
Except the model was flawed and carried much higher tail risks. Risks that the ratings agencies failed to catch when they gave them AAA ratings in the debt market.
And a lot of conforming mortgages are held by government-sponsored enterprises like Fanny Mae. Key point those asset holding companies don't have to deal with profit and losses like ordinary investment businesses.
https://en.wikipedia.org/wiki/Fannie_Mae
https://en.wikipedia.org/wiki/Fannie_Mae
This begins to effectively sound like government subsidised mortgages, two steps removed and by the back door… huh.
People in the US refinance all of the time. Usually either because the mortgage rates are now low enough to lower their payment significantly or to take some equity out as cash (for renovations, another down payment or other reasons). I bought my current home 8 years ago and have refinanced twice.
> Is this not quite risky for banks? Not that banks taking a risk is bad, but it seems a very long bet for them.
Not really. Mortgages are (mostly) bundled and on-sold to investors which assume the risk of default and interest rate changes. The originating bank collects are premium for the loan and moves on to the next one.
Not really. Mortgages are (mostly) bundled and on-sold to investors which assume the risk of default and interest rate changes. The originating bank collects are premium for the loan and moves on to the next one.
Isn’t one of those big investors Fanny Mae?
US mortgages are unique I believe. Canada does 5 year fixed and you refinance at the current rate.
I believe the US mortgages work because of Fannie Mae/Mac and a market in mortgage backed securities ( MBOs? I thought they caused the 2008 crisis but I think they are still a thing with better risk management, I dunno?).
I believe the US mortgages work because of Fannie Mae/Mac and a market in mortgage backed securities ( MBOs? I thought they caused the 2008 crisis but I think they are still a thing with better risk management, I dunno?).
It was auction-rate mortgage backed securities that triggered everything. If you see those start showing up again, know we're heading for an awful place.
It’s not, my primary option when buying in France was 10-20 year fixed
I assume there are a good deal more countries with that sort of market
I assume there are a good deal more countries with that sort of market
> And I imagine that makes refinancing quite rare?
You can refinance whenever you want if you qualify
It makes sense when rates go down
You can refinance whenever you want if you qualify
It makes sense when rates go down
In case you're wondering, no they're not borrowing $7k. The $7k is the monthly repayment. What a silly headline.
We bought our home in Washington DC in 2019. Our mortgage is about $2000 a month, I could not imagine or even contemplate trying to pay a $7000 a month mortgage.
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Many people bought at like 13% in the 80’s and refinanced down over time as rates came back to earth. In a couple years I’m sure you’ll see the rates drop at least a couple points. Worst case scenario, you sell the house.
Worst case scenario is house prices drop causing you to go underwater and eventually bankrupt. There is a lot of risk in buying something beyond your means and gambling that will change.
You only go bankrupt if you can’t afford the mortgage. If you can afford the mortgage you’ll be fine. Unless the economy collapses from all angles which at that point you’ll be worried about a lot more than bankruptcy.
If you can afford the mortgage then it's within your means. If you take a $7k/mo mortgage assuming rates will drop to make it long-term sustainable...
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If banks are approving people for 7k mortgages that they cannot afford long term I expect another MBS crisis in the near future. Originators are supposed to do due diligence by law to prevent this exact scenario… now people may be taking these on with the ability to afford payments but the desire to refi so they can spend in other areas which is an entirely different scenario than what you’re suggesting. One requires originator fraud the other is rosy financial planning. There’s the possibility that markets nationwide crater and millions of people go bankrupt to escape underwater mortgages which would do serious economic damage but that’s such an extreme scenario that it’s not worth seriously considering.
> Worst case scenario is house prices drop causing you to go underwater and eventually bankrupt.
Why would you go bankrupt if you are underwater on a fixed rate mortgage ?
I’m not advocating buying beyond your means, but prices going up or down doesn’t come into play if you don’t sell
Why would you go bankrupt if you are underwater on a fixed rate mortgage ?
I’m not advocating buying beyond your means, but prices going up or down doesn’t come into play if you don’t sell
Bankruptcy is temporary. I wish I had been willing to risk it in my 20s.
The income rules for securing a mortgage and how much house one could afford were also much stricter in the 1980s.
All of this interest-rate hiking hasn't done squat to stop inflation. Why? Because the money supply isn't causing inflation. Oligopoly and monopoly are causing inflation, but those in power are too gutless or ignorant to call it out... and the news media long ago stopped doing any actual investigation or asking intelligent questions (with a couple of exceptions).
We all know the Republicans won't call it out, because they're corporate toadies. But the Biden administration hasn't either, except for a few limp complaints.
So now we have high interest rates AND high prices. Great work, "representatives."
We all know the Republicans won't call it out, because they're corporate toadies. But the Biden administration hasn't either, except for a few limp complaints.
So now we have high interest rates AND high prices. Great work, "representatives."
> hasn't done squat to stop inflation
U.S. inflation is down to 3 percent in June from a high of 9% last year. You could argue that interest rate hikes didn't cause that change, but interest rates are the Occam's razor explanation.
https://www.usinflationcalculator.com/inflation/current-infl...
U.S. inflation is down to 3 percent in June from a high of 9% last year. You could argue that interest rate hikes didn't cause that change, but interest rates are the Occam's razor explanation.
https://www.usinflationcalculator.com/inflation/current-infl...
They've been jacking interest rates for quite a while to no avail. So now that prices are sky-high, the oligopolies have slowed their assault.
"Reduced inflation" does nothing to roll back the disgusting price-gouging that has gone on for years now. So the gouging is decelerating. Whoop-dee-doo.
"Reduced inflation" does nothing to roll back the disgusting price-gouging that has gone on for years now. So the gouging is decelerating. Whoop-dee-doo.
Dems are also corporate toadies. We can say it out.
They are. Especially these days as Republicans lean more heavily into culture wars and less into the economy (eg see DeSantis recent attacks on Disney and Anheuser-Busch), Democrats are becoming the pro business party.
Oh really? Based on what behavior?
Remember that it's the Republicans who piss and moan about "illegals stealing our jobs," but refuse to require employers to use E-Verify. Why? Because the corporations they serve rely on cheap illegal labor.
It's Republicans who oppose the government setting up the means for us to pay our taxes free online. Why? Because they're toadies to H&R Block and Intuit.
They also opposed Net Neutrality. Why? Because they're toadies to telcos. Do you need more examples?
Remember that it's the Republicans who piss and moan about "illegals stealing our jobs," but refuse to require employers to use E-Verify. Why? Because the corporations they serve rely on cheap illegal labor.
It's Republicans who oppose the government setting up the means for us to pay our taxes free online. Why? Because they're toadies to H&R Block and Intuit.
They also opposed Net Neutrality. Why? Because they're toadies to telcos. Do you need more examples?
I don't think the plebs should taking side hard. Remember it's the dem who sabotage the repair law Louis Rossman fought so hard far. They are both bad, dems are less so. The plebs only have themselves to rely on
I'm not familiar with that incident. I'd be interested to read about it if you have a link.
To some extent, but it's a far lesser extent.
To a lesser extent I agree. But I don't think it's far behind.
dangerous play (as I've read so far)
home values are hugely inflated
when they drop too, you'll end up with negative equity and possibly a denied refinancing
worst of both worlds
home values are hugely inflated
when they drop too, you'll end up with negative equity and possibly a denied refinancing
worst of both worlds
Why? The government will bail them out.
As long as lots of people get crushed simultaneously, the banks will demand to be bailed out, too.
A bunch of Southern California homes are already in this state--the banks are allowing the "owners" to simply pay the tax and interest and still live there. Why? Because if they foreclose on just a few too many houses, the basis value will plunge, the "owners" will walk away, and the bank will be stuck with a house they can't sell which will promptly get vandalized.
Only suckers use cash as long as the government keeps bailing them out.
As long as lots of people get crushed simultaneously, the banks will demand to be bailed out, too.
A bunch of Southern California homes are already in this state--the banks are allowing the "owners" to simply pay the tax and interest and still live there. Why? Because if they foreclose on just a few too many houses, the basis value will plunge, the "owners" will walk away, and the bank will be stuck with a house they can't sell which will promptly get vandalized.
Only suckers use cash as long as the government keeps bailing them out.
That is because USD is reserve currency. In coming 2 decades you will see RMB and Ruble dominates. Already in many parts of Asia RMB is used like USD way more than USD like 5 ywars ago. Once BRICs and digital yuan kicks into high gear in 3 years, tsunami of recessions and inflations hitting USA shores like crazy. Many of my friends there now shifted out of USD and park their money in regional currencies like Yuan, Yen, SG, and even Ruble. Some opt heavily in gold and park it in Singapore.
The ruble? Really? There is a chance the RMB will become a more highly trade and used more as a 'basw' currency, but there is absolutely zero chance the ruble will.
BRIC's is one of the weakest coalitions recently formed - SA just stated today they won't let EU president in, it's an absolute paper tiger.
To out in perspective, I'd love to see EU bring in a strong coalition to offset the US dominance because competition is always good.
BRIC's is one of the weakest coalitions recently formed - SA just stated today they won't let EU president in, it's an absolute paper tiger.
To out in perspective, I'd love to see EU bring in a strong coalition to offset the US dominance because competition is always good.
We might see a pull back to December 2019 prices but there's no way absolute house prices will crash to 2014 or 2012 prices. Weak markets might continue to see a decline in prices but in competitive markets (read: where the jobs/growth are/is) demand far outstrips supply to the tune of about 7 million homes per the Fed.
There is so much more money in the economy since COVID. A pullback to 2019 prices seems very unlikely.
I wouldn’t ever say “no way” when it comes to markets. A black swan could always be right around the corner.
But aren't those the places being most damaged by the end of free money?
I don’t think so. Most current homeowners have absolutely no incentive to sell, and the market has to work both ways. The high interest rates and increase in housing prices mean if you bought a home within the last 15 years there’s a 0% chance a homeowner could buy the same home they live in today for anywhere similar in price.
It’s not like stocks where you can sell to reap your gains and just hold onto the cash or move it to a different asset. You have to live somewhere. For most people, selling their home now means moving into a worse quality rental and paying more, or paying 2-3x what you were paying on your 2013 mortgage payment for the same quality home.
Prices aren’t going to come down just because interest rates and prices scare away buyers. The sellers don’t care that there are no buyers because they’re also not selling. It’s a weird unhealthy place for the economy where everyone except the banks seem to be losing.
It’s not like stocks where you can sell to reap your gains and just hold onto the cash or move it to a different asset. You have to live somewhere. For most people, selling their home now means moving into a worse quality rental and paying more, or paying 2-3x what you were paying on your 2013 mortgage payment for the same quality home.
Prices aren’t going to come down just because interest rates and prices scare away buyers. The sellers don’t care that there are no buyers because they’re also not selling. It’s a weird unhealthy place for the economy where everyone except the banks seem to be losing.
It's offset by a massive housing shortage nation wide. 7 million new homes is like 175 new, large apartment complexes in every city over population 100,000.
But you have a place to live and you don’t have to worry about unforeseen displacement or rent hikes.
I’ve always believed that if you want to buy a home and can afford it you should buy it. Timing the market is too hard.
Will it make you house poor? Possibly, especially in a place like the Bay Area where many people will risk being house poor to own a home.
I’ve always believed that if you want to buy a home and can afford it you should buy it. Timing the market is too hard.
Will it make you house poor? Possibly, especially in a place like the Bay Area where many people will risk being house poor to own a home.
Rent makes sense sometimes. Like when I was paying $1000/month for an apartment in Beijing that the landlord was trying to sell for $1 million. No point of buying into a crazy market if rents are low enough.
> when they drop too, you'll end up with negative equity and possibly a denied refinancing
If rates go down prices will rise
If rates go down prices will rise
Not necessarily. If rates go down, there will be more liquidity, which could make prices go down. Right now inventory is super tight since most people have good rates and would lose a lot if they sold and bought something else.
vkou(1)
I know this is peak hn but the mortgage rate doesn't matter if you don't have a mortgage. Ideally, higher mortgage rates should push home prices lower and benefit cash buyers.
Who is buying million-dollar homes with cash? (This prior question was rhetorical. The answer is: the very to ultra wealthy.) And where are home prices lowering?
My home, just purchased 1.5 years ago, would be well beyond unaffordable now. How is that not insane?
My home, just purchased 1.5 years ago, would be well beyond unaffordable now. How is that not insane?
Immigrants. 95% (made up stat) may be poor but the 5% who are not, can afford to. In Canada, there is a recent narrative which I think is correct that immigrants are driving our inflation. We expanded our population of 30 million by about a million in the last year. That's a million new household formations, and some people bought a buttload of cash.
In the SF bay area people are throwing $4, 5, 6 million at houses in cash all over the place. No contingencies, 7 day closing. The high end of the market has slowed a lot, though, and houses are having to repeatedly lower prices to get bids. The market up to about $4M has not slowed noticeably, possibly because supply has slowed more quickly than demand; people are still bidding hundreds of thousands over asking.
Realistically, however, high mortgage rates prevent current homeowners from selling (as they couldn’t match their current rate), thus utterly trashing supply.
The reality is that people need to live somewhere. Cash buyers rolling in and making them a rental property just takes more property off the market. It is a runaway situation.
The rate is irrelevant. Matching the ratw doesn't matter. Matching the approproate monthly payment is all that matters.
> Matching the approproate monthly payment is all that matters.
I'm not sure you follow. Monthly payment, assuming the same loan term and the buyer not losing equity, is (amount borrowed + interest) / term. If the person selling their house was paying a lower rate and their house gained in value, and the house they are buying is worth the same (as the housing market got broadly more expensive) but the interest rate is higher, it means that to match the monthly payment one would have to buy a 'cheaper' house than their current. That just isn't favorable.
I'm not sure you follow. Monthly payment, assuming the same loan term and the buyer not losing equity, is (amount borrowed + interest) / term. If the person selling their house was paying a lower rate and their house gained in value, and the house they are buying is worth the same (as the housing market got broadly more expensive) but the interest rate is higher, it means that to match the monthly payment one would have to buy a 'cheaper' house than their current. That just isn't favorable.
Yes, which means downsizing. Need to downsize will put people off selling. People being put off selling reduces supply. Small supply keeps prices high.
It would improve liquidity but most people selling their homes also need to buy a new one.
This is incredibly financially unsound advice. A mortgage is the cheapest, most secure debt most people will have. Even today, with current interest rates, if your goal is to buy a home, it is far more financially sound to take out a mortgage and invest your liquid cash.
Of course the more fundamental question is, should you buy a home at all? And that's a complex decision. But if you do make that decision, sinking significant liquid funds into property instead of using relatively inexpensive leverage is, as a general rule, a terrible financial decision.
Of course the more fundamental question is, should you buy a home at all? And that's a complex decision. But if you do make that decision, sinking significant liquid funds into property instead of using relatively inexpensive leverage is, as a general rule, a terrible financial decision.
I am not good at investing (lost money every single time I've tried). Liquid cash gets spent. I am paying off my 5 year fixed mortgage as fast as I can, as I will be up for renewal at the end of next year.
Some people don't have the financial savvy or time to optimize. One size does not fit all.
Some people don't have the financial savvy or time to optimize. One size does not fit all.
And that's why normies investors shouldn't be actively investing (I.e. picking individual stocks).
Dump your money into an all-market index fund and forget about it for 25 years. This requires zero "savvy" and not a lot of time. It does require a bit of research to develop some essential financial knowledge, but that's something everyone can benefit from.
If you can't do that much and you're in Canada, look at Wealthsimple, which is a robo-advisors that does this all for you. If you're not Canadian, there maybe be similar robo-advisors that automate passive investing that might be worth looking at.
One size may not fit all, but it absolutely fits most, and my bet is, no offense, you're actually not that special (I know I'm not).
Dump your money into an all-market index fund and forget about it for 25 years. This requires zero "savvy" and not a lot of time. It does require a bit of research to develop some essential financial knowledge, but that's something everyone can benefit from.
If you can't do that much and you're in Canada, look at Wealthsimple, which is a robo-advisors that does this all for you. If you're not Canadian, there maybe be similar robo-advisors that automate passive investing that might be worth looking at.
One size may not fit all, but it absolutely fits most, and my bet is, no offense, you're actually not that special (I know I'm not).
Assuming a perfectly spherical market, yes, high rates should push down prices.
It doesn't. I'm in DC, and prices have basically stayed put give or take a few percentage points. It's obvious why: if you own a house, you're going to be very resistant to taking a 100k+ loss when selling it, especially when the place you might buy is also stuck at a high price and will require paying double the interest rate.
So in practice, housing costs just shot up 40% until further notice for anyone who can't stay put.
It doesn't. I'm in DC, and prices have basically stayed put give or take a few percentage points. It's obvious why: if you own a house, you're going to be very resistant to taking a 100k+ loss when selling it, especially when the place you might buy is also stuck at a high price and will require paying double the interest rate.
So in practice, housing costs just shot up 40% until further notice for anyone who can't stay put.
I think it's hard for increases in mortgage rates to push home prices lower due to other things in the system. It puts a lot of pressure on potential sellers to stay put instead of selling. It makes keeping a place and renting it potentially more attractive. It can put upward pressure on rents.
For example, if you own a place with a 3% mortgage, you aren't likely to sell it and buy a new place with a 7% mortgage. If you bought a place at $500,000 with 20% down, your mortgage is $1,686/mo. Let's say that prices go down so that a new place at 7% would cost $1686/mo. Prices would have to dip to $317,000, a 37% decrease. After 5 years of owning your home that you purchased for $500,000, you still owe $356,000 on your mortgage. If you sold your place for $317,000 and then bought another place for $317,000, you'd have lost the $100,000 down payment on the first place, need a $63,000 down payment for the new place, have gotten zero equity out of your mortgage payments, and still have the same $1,686/mo payment. So you certainly wouldn't sell for $317,000.
If you sell for $450,000 and buy another place for $450,000, your monthly payment goes up by $527/mo. You need $90,000 for the down payment on the new place and you will have gotten back your $100,000 + $44,000 in equity from the first place so you'll have $54,000 in additional funds. You could invest that $54,000 and try and get a 10% return getting you $5,400/year or $450/mo. That's shy of the $527/mo increase in your monthly so you're still losing money.
So if you own a place with a low interest rate, you don't want to sell.
For people who are on the cusp of renting vs buying, it offers an incentive to continue renting for a few more years. A $750,000 place is $2,530/mo at 3%, but it's $3,992 at 7%. That's $1,462/mo more expensive and a 58% increase in the monthly mortgage payment. Of course, a strong incentive to continue renting puts upward pressure on rents.
Upward pressure on rents in turn offers potential buyers an incentive to pay more to own a place. If your rent is going up a lot, that makes buying a more attractive proposition and you're willing to pay more. The fear that rapidly increasing rents puts into peoples' heads also pushes prices higher.
Even if you own a place and are looking to buy a new place, it can make more sense to rent out the old place given your costs. As noted, there's upward pressure on rents as some buyers delay and your costs to rent the unit are going to be substantially less than someone trying to buy at 7%.
Yes, higher mortgage rates should put downward pressure on home prices. However, there's a lot of other stuff that pushes back on that. Sellers often can't afford to sell if the property is underwater. Even if they're not underwater, it makes more financial sense for them to stay put. It even makes more sense for them to rent out the place even if they're moving because of the good interest rate.
There just aren't strong scenarios for higher interest rates pushing housing prices significantly lower. Sure, the mortgage on that $750,000 place is now 58% more expensive. Not everyone will make decisions the same way, but certainly some owners would rather rent out the place at $3,000/mo than sell it for less and many potential buyers would rather put off ownership for a couple years given the huge increases from the mortgage rates. Some renters will be willing to pay more because home ownership is now more expensive and as rents increase that means that even more expensive ownership opportunities don't look as expensive.
I think the biggest thing is that people don't expect things to continue being bad. They expect to refinance their mortgage so even if rates are high for a year or two, they're confident they won't actually be paying that much over the long-run. If that's your mentality, then higher rates put limited downward pressure on housing prices - while the rest still exert their upward pressure. At some point there's a lot of confidence behind the market. It might be misplaced confidence. Maybe we'll be in 2030 with mortgage rates sticking at 7% and everyone will end up having paid a ton more money than they were expecting.
I will say that there is some evidence of prices lowering a bit in many markets - but they aren't lowering anywhere near enough to overcome the difference in mortgage payments. Again, there's a lot of other pressures keeping prices up (even if they're slightly down). And if most buyers think "it's just a couple years at the high rate so I'll budget $10k to refinance plus $35k in higher payments over two years, $705k is the same as $750k", then we aren't going to see major decreases in housing prices. Buyers "know" (or think they know) that interest rates will come down and so they just need to factor in the extra costs in the meantime. If rent is going up 10-15%, housing normally goes up 2-3%, and the interest rate/refinance cost is going to cost you ~6% of the home's value, then maybe a 0-4% decrease in house prices is the most that makes sense - or even an increase given the upward pressure from rental hikes (if that's happening in your area).
In the 2008 mortgage crisis, owners didn't have the option to stay. They defaulted on their mortgages. Demand was really soft because banks didn't want to lend. Unemployment was high. Today, there's nothing forcing people to sell - in fact, that 3% mortgage rate could be a huge asset to hang onto. Today, the job market is strong and especially strong in many cities keeping demand high. Even the stock market is just at such highs that many people feel like they have money to spend - in 2008, the S&P dropped around 50% so people had a ton less money if they wanted to liquidate stocks for a down payment. There's just a lot keeping prices high even in the face of higher interest rates today. That doesn't mean we won't see some declines, but without more going on it'll be hard to fall too much. There's too much confidence, few sellers, and a lot of demand.
For example, if you own a place with a 3% mortgage, you aren't likely to sell it and buy a new place with a 7% mortgage. If you bought a place at $500,000 with 20% down, your mortgage is $1,686/mo. Let's say that prices go down so that a new place at 7% would cost $1686/mo. Prices would have to dip to $317,000, a 37% decrease. After 5 years of owning your home that you purchased for $500,000, you still owe $356,000 on your mortgage. If you sold your place for $317,000 and then bought another place for $317,000, you'd have lost the $100,000 down payment on the first place, need a $63,000 down payment for the new place, have gotten zero equity out of your mortgage payments, and still have the same $1,686/mo payment. So you certainly wouldn't sell for $317,000.
If you sell for $450,000 and buy another place for $450,000, your monthly payment goes up by $527/mo. You need $90,000 for the down payment on the new place and you will have gotten back your $100,000 + $44,000 in equity from the first place so you'll have $54,000 in additional funds. You could invest that $54,000 and try and get a 10% return getting you $5,400/year or $450/mo. That's shy of the $527/mo increase in your monthly so you're still losing money.
So if you own a place with a low interest rate, you don't want to sell.
For people who are on the cusp of renting vs buying, it offers an incentive to continue renting for a few more years. A $750,000 place is $2,530/mo at 3%, but it's $3,992 at 7%. That's $1,462/mo more expensive and a 58% increase in the monthly mortgage payment. Of course, a strong incentive to continue renting puts upward pressure on rents.
Upward pressure on rents in turn offers potential buyers an incentive to pay more to own a place. If your rent is going up a lot, that makes buying a more attractive proposition and you're willing to pay more. The fear that rapidly increasing rents puts into peoples' heads also pushes prices higher.
Even if you own a place and are looking to buy a new place, it can make more sense to rent out the old place given your costs. As noted, there's upward pressure on rents as some buyers delay and your costs to rent the unit are going to be substantially less than someone trying to buy at 7%.
Yes, higher mortgage rates should put downward pressure on home prices. However, there's a lot of other stuff that pushes back on that. Sellers often can't afford to sell if the property is underwater. Even if they're not underwater, it makes more financial sense for them to stay put. It even makes more sense for them to rent out the place even if they're moving because of the good interest rate.
There just aren't strong scenarios for higher interest rates pushing housing prices significantly lower. Sure, the mortgage on that $750,000 place is now 58% more expensive. Not everyone will make decisions the same way, but certainly some owners would rather rent out the place at $3,000/mo than sell it for less and many potential buyers would rather put off ownership for a couple years given the huge increases from the mortgage rates. Some renters will be willing to pay more because home ownership is now more expensive and as rents increase that means that even more expensive ownership opportunities don't look as expensive.
I think the biggest thing is that people don't expect things to continue being bad. They expect to refinance their mortgage so even if rates are high for a year or two, they're confident they won't actually be paying that much over the long-run. If that's your mentality, then higher rates put limited downward pressure on housing prices - while the rest still exert their upward pressure. At some point there's a lot of confidence behind the market. It might be misplaced confidence. Maybe we'll be in 2030 with mortgage rates sticking at 7% and everyone will end up having paid a ton more money than they were expecting.
I will say that there is some evidence of prices lowering a bit in many markets - but they aren't lowering anywhere near enough to overcome the difference in mortgage payments. Again, there's a lot of other pressures keeping prices up (even if they're slightly down). And if most buyers think "it's just a couple years at the high rate so I'll budget $10k to refinance plus $35k in higher payments over two years, $705k is the same as $750k", then we aren't going to see major decreases in housing prices. Buyers "know" (or think they know) that interest rates will come down and so they just need to factor in the extra costs in the meantime. If rent is going up 10-15%, housing normally goes up 2-3%, and the interest rate/refinance cost is going to cost you ~6% of the home's value, then maybe a 0-4% decrease in house prices is the most that makes sense - or even an increase given the upward pressure from rental hikes (if that's happening in your area).
In the 2008 mortgage crisis, owners didn't have the option to stay. They defaulted on their mortgages. Demand was really soft because banks didn't want to lend. Unemployment was high. Today, there's nothing forcing people to sell - in fact, that 3% mortgage rate could be a huge asset to hang onto. Today, the job market is strong and especially strong in many cities keeping demand high. Even the stock market is just at such highs that many people feel like they have money to spend - in 2008, the S&P dropped around 50% so people had a ton less money if they wanted to liquidate stocks for a down payment. There's just a lot keeping prices high even in the face of higher interest rates today. That doesn't mean we won't see some declines, but without more going on it'll be hard to fall too much. There's too much confidence, few sellers, and a lot of demand.
> In the 2008 mortgage crisis, owners didn't have the option to stay. They defaulted on their mortgages.
People were doing ARMs, and interest only loans betting on appreciation & them being able to refinance or selling for profit
When that option dried up there was no path to success
Those that bought at a bad time but were able to pay still kept their homes and have recovered now
People were doing ARMs, and interest only loans betting on appreciation & them being able to refinance or selling for profit
When that option dried up there was no path to success
Those that bought at a bad time but were able to pay still kept their homes and have recovered now
Thank you for taking the time to write this out. Where I am, rising interest rates have at best slowed the rate at which prices were increasing and dried up the market. I felt like there were other factors that will keep housing prices high and supply low, and you laid them out in a very clear way.