8 ms·

Whatever the case, what you end up with is an asset whose actual value is tied to the interest rate (interest goes down, people can afford larger loans with the

by joppy 5y ago

Whatever the case, what you end up with is an asset whose actual value is tied to the interest rate (interest goes down, people can afford larger loans with the same repayments, therefore houses are worth more). This is a highly leveraged situation: if you take out a $1m loan and then interest rates go up, you're still liable for the whole $1m even though your actual asset might only be worth $900k now. I think this is one of the big dangers of having an essential need like housing cost such a large multiple of income.

game_the0ry 5y ago
Agreed
exporectomy 5y ago
Home ownership is not an essential need. People aren't excluded from housing because of that risk. They can just rent from a landlord who's taking that risk themselves.
- deleted 5y ago
  [deleted]
- thayne 5y ago
  True. Renting has other risks though. The Landlord can increase the price dramatically at least as often as you renew your contract (usually a year in the US), or force you to move out because they sold the property, or really almost any reason. And because moving has such a high transaction cost, landlords can often get away with treating tenants pretty badly, because putting up with a bad landlord is often less bad than having to relocate your home.
  - exporectomy 5y ago
    It's almost as if playing in the rat race isn't easy or fair. Moving to a rural area or living on social welfare is usually also an option but you have to quit the rat-race to do that and miss out on all the wealth and social status.
    - thayne 5y ago
      If you move to a rural area you still have to buy or rent, the prices are just lower, and there are a lot less options to rent.
zepto 5y ago
Not if you get a fixed rate.
- ed25519FUUU 5y ago
  When I checked out a 5/1 arm at around 2.25%, even the maximum interest rate was 7.5%, which is pretty good historically.
- hahajk 5y ago
  If you try to sell your asset, buyers will be stuck with a higher interest rate, which pushes up the effective price of your home (and the extr money doesn’t go to you.)
- jjnoakes 5y ago
  I think you misunderstood the parent comment. Even with a fixed interest rate, you still owe the entirety of your borrowed amount on the $1m purchase to the lender, but your property value may drop if the interest rates go up because, assuming the market value is tied to the interest rate, new buyers won't be able or willing to borrow $1m to buy your place at a rate higher than what you borrowed your $1m at. For the same monthly payment as you have now, a new buyer may only be able to borrow enough to afford a $900k home. Someone with the same income and monthly expense limit as you wouldn't be able to afford your home, assuming rates went up, which is why the value might drop - fewer buyers.
  - zepto 5y ago
    True. But that’s nonetheless likely to be transient over a reasonable time horizon for home ownership, e.g. 10 years.
    - jjnoakes 5y ago
      It affects things like refinancing, pmi removal, and helocs as well when appraisals come in lower.
bko 5y ago
> if you take out a $1m loan and then interest rates go up, you're still liable for the whole $1m even though your actual asset might only be worth $900k now. I think this is one of the big dangers of having an essential need like housing cost such a large multiple of income. You could always walk away. Better to be under water on a mortgage than own it outright. This is called a strategic default. Lenders know this which is why they require a substantial down payment (typically 20% in the US) Most people wouldn't do it if they're slightly under water. But eventually many people would consider walking away and taking a hit on their credit score, which get totally wiped out after 7 years anyway.
- RayVR 5y ago
  This is only true in states with non-recourse loans. Many states have full recourse home loans that would require the homeowners declare bankruptcy to "walk away"
  - TedDoesntTalk 5y ago
    Yeah, and I don’t think bankruptcy disappears from your credit report after 7 years like other items. Does it?
    - yurishimo 5y ago
      Bankruptcy does eventually disappear I think, or if it doesn't there are legal requirements not to hold it against you after X years without a problem on your end. It's been a while since I've looked into it.
      - ncphil 5y ago
        The irony, of course, is that the US Bankruptcy Code provides you can't declare bankruptcy again until 7 years have passed. So creditors theoretically have less risk during the period they generally refuse credit to the newly bankrupt. Of course none of that applies to business bankruptcy, where the old company is often dissolved but you're often looking to the same former principal(s) for personal guarantees of the new company's obligations.
woofie11 5y ago
Kinda. If I buy a 1M home at 2.5% interest, I have a $4,000 monthly payment. If rates go to 6%: - Housing prices plummet to $600,000, assuming people are willing to spend the same per month. - My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly. - If I move out, and I rent out my home, it covers monthly payments approximately exactly. The only time the owner is in danger is if: 1) They need to move. 2) They can't rent out the original property. Rent works out since while the home is a liability, with 6% interest rates, the 2.5% loan is an asset. As a footnote, what I expect is actually happening here is people are anticipating high inflation. If that happens, this isn't a bubble. Real housing prices might be fixed, at least looking out a few years.
- SilasX 5y ago
  >- My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly. >- If I move out, and I rent out my home, it covers monthly payments approximately exactly. In any situation where interest rates go to 6%, there will probably also be some upheaval that affects your earnings and ability to rent it out at the present rental rate. The risks are correlated.
- xyzzy123 5y ago
  Not sure about the US but fixed-rate term in Australia is about 5 years. Nobody would give you a 30 year fixed rate. You'd eventually have to pay 6% on the $1M.
  - moosedev 5y ago
    30 year fixed rate is actually the “normal”/common mortgage in the US. I moved to the US from the UK, where mortgages look more like Australia’s, and I still find it amazing you can fix such a low rate for so long here.
    - aidenn0 5y ago
      The weird thing is that 5 year adjustable rates are higher then 30yr. fixed. That only makes sense if interest rates will go down over the next 5 years, which seems unlikely to me.
fshbbdssbbgdd 5y ago
I have a ~million dollar fixed rate mortgage. If rates go up, I’ll be sad that the value of my house went down. On the other hand, I’ll be very happy to have a large fixed rate loan. Let’s call my mortgage rate X%, and let us assume that rates go to X+5. Then I can invest money to earn at (X+5)%, which means my loan is essentially a $50k/year annuity. My only wish would be that I could make the loan even bigger. On the other hand, if the fed decides to allow inflation instead of raising rates, then the value of my loan will melt away and my home’s price will keep going up (that’s what has happened so far).
- throw123123123 5y ago
  The problem is that in a scenario of rates going up, both houses and general stock investments will go down together. They rarely diverge.
  - fshbbdssbbgdd 5y ago
    If rates go up to X+5, then I ought to be able to find bonds that pay X+5, no?
    - bogomipz 5y ago
      No. 30 year mortgages and 10 year treasuries move in unison but they are not the same rate. You can see this on the first graph here: https://www.thebalance.com/treasury-note-and-mortgage-rate-relationship-3305734 https://www.thebalance.com/treasury-note-and-mortgage-rate-r...
      - fshbbdssbbgdd 5y ago
        Treasuries are some of the lowest-yielding bonds out there.
        bogomipz 5y ago
        Yes and treasures are the only bonds that move in lockstep with 30 year mortgages. When people talk about the correlation between bond yields and mortgages those are exactly the ones they are referring to. US Treasuries also are considered among the safest, least risky assets out there. This is true globally and has been for a very, very long time. This is all succinctly explained in the link I posted above. Lastly bond prices have an inverse relationship with interest rates, which means that as interest rates rise, bond prices go down. So no, when rates go up to x+5 you will never be able to find bonds that pay x+5.
AmericanChopper 5y ago
The value of all yielding assets is tied to interest rates. The risk free rate is a bench mark for measuring any type of return, so any time you change that you’re going to influence the valuation of everything. There’s also a very clear distinction between the idea of housing and home ownership. People need a place to live, they don’t need to have a property investment. You and I need healthcare, but neither of us need to own a hospital.

by joppy 5y ago

game_the0ry 5y ago

Agreed

exporectomy 5y ago

Home ownership is not an essential need. People aren't excluded from housing because of that risk. They can just rent from a landlord who's taking that risk themselves.

deleted 5y ago
[deleted]
thayne 5y ago
True. Renting has other risks though. The Landlord can increase the price dramatically at least as often as you renew your contract (usually a year in the US), or force you to move out because they sold the property, or really almost any reason. And because moving has such a high transaction cost, landlords can often get away with treating tenants pretty badly, because putting up with a bad landlord is often less bad than having to relocate your home.
- exporectomy 5y ago
  It's almost as if playing in the rat race isn't easy or fair. Moving to a rural area or living on social welfare is usually also an option but you have to quit the rat-race to do that and miss out on all the wealth and social status.
  - thayne 5y ago
    If you move to a rural area you still have to buy or rent, the prices are just lower, and there are a lot less options to rent.

zepto 5y ago

Not if you get a fixed rate.

ed25519FUUU 5y ago
When I checked out a 5/1 arm at around 2.25%, even the maximum interest rate was 7.5%, which is pretty good historically.
hahajk 5y ago
If you try to sell your asset, buyers will be stuck with a higher interest rate, which pushes up the effective price of your home (and the extr money doesn’t go to you.)
jjnoakes 5y ago
I think you misunderstood the parent comment. Even with a fixed interest rate, you still owe the entirety of your borrowed amount on the $1m purchase to the lender, but your property value may drop if the interest rates go up because, assuming the market value is tied to the interest rate, new buyers won't be able or willing to borrow $1m to buy your place at a rate higher than what you borrowed your $1m at. For the same monthly payment as you have now, a new buyer may only be able to borrow enough to afford a $900k home. Someone with the same income and monthly expense limit as you wouldn't be able to afford your home, assuming rates went up, which is why the value might drop - fewer buyers.
- zepto 5y ago
  True. But that’s nonetheless likely to be transient over a reasonable time horizon for home ownership, e.g. 10 years.
  - jjnoakes 5y ago
    It affects things like refinancing, pmi removal, and helocs as well when appraisals come in lower.

bko 5y ago

> if you take out a $1m loan and then interest rates go up, you're still liable for the whole $1m even though your actual asset might only be worth $900k now. I think this is one of the big dangers of having an essential need like housing cost such a large multiple of income. You could always walk away. Better to be under water on a mortgage than own it outright. This is called a strategic default. Lenders know this which is why they require a substantial down payment (typically 20% in the US) Most people wouldn't do it if they're slightly under water. But eventually many people would consider walking away and taking a hit on their credit score, which get totally wiped out after 7 years anyway.

RayVR 5y ago
This is only true in states with non-recourse loans. Many states have full recourse home loans that would require the homeowners declare bankruptcy to "walk away"
- TedDoesntTalk 5y ago
  Yeah, and I don’t think bankruptcy disappears from your credit report after 7 years like other items. Does it?
  - yurishimo 5y ago
    Bankruptcy does eventually disappear I think, or if it doesn't there are legal requirements not to hold it against you after X years without a problem on your end. It's been a while since I've looked into it.
    - ncphil 5y ago
      The irony, of course, is that the US Bankruptcy Code provides you can't declare bankruptcy again until 7 years have passed. So creditors theoretically have less risk during the period they generally refuse credit to the newly bankrupt. Of course none of that applies to business bankruptcy, where the old company is often dissolved but you're often looking to the same former principal(s) for personal guarantees of the new company's obligations.

woofie11 5y ago

Kinda. If I buy a 1M home at 2.5% interest, I have a $4,000 monthly payment. If rates go to 6%: - Housing prices plummet to $600,000, assuming people are willing to spend the same per month. - My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly. - If I move out, and I rent out my home, it covers monthly payments approximately exactly. The only time the owner is in danger is if: 1) They need to move. 2) They can't rent out the original property. Rent works out since while the home is a liability, with 6% interest rates, the 2.5% loan is an asset. As a footnote, what I expect is actually happening here is people are anticipating high inflation. If that happens, this isn't a bubble. Real housing prices might be fixed, at least looking out a few years.

SilasX 5y ago
>- My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly. >- If I move out, and I rent out my home, it covers monthly payments approximately exactly. In any situation where interest rates go to 6%, there will probably also be some upheaval that affects your earnings and ability to rent it out at the present rental rate. The risks are correlated.
xyzzy123 5y ago
Not sure about the US but fixed-rate term in Australia is about 5 years. Nobody would give you a 30 year fixed rate. You'd eventually have to pay 6% on the $1M.
- moosedev 5y ago
  30 year fixed rate is actually the “normal”/common mortgage in the US. I moved to the US from the UK, where mortgages look more like Australia’s, and I still find it amazing you can fix such a low rate for so long here.
  - aidenn0 5y ago
    The weird thing is that 5 year adjustable rates are higher then 30yr. fixed. That only makes sense if interest rates will go down over the next 5 years, which seems unlikely to me.

fshbbdssbbgdd 5y ago

I have a ~million dollar fixed rate mortgage. If rates go up, I’ll be sad that the value of my house went down. On the other hand, I’ll be very happy to have a large fixed rate loan. Let’s call my mortgage rate X%, and let us assume that rates go to X+5. Then I can invest money to earn at (X+5)%, which means my loan is essentially a $50k/year annuity. My only wish would be that I could make the loan even bigger. On the other hand, if the fed decides to allow inflation instead of raising rates, then the value of my loan will melt away and my home’s price will keep going up (that’s what has happened so far).

throw123123123 5y ago
The problem is that in a scenario of rates going up, both houses and general stock investments will go down together. They rarely diverge.
- fshbbdssbbgdd 5y ago
  If rates go up to X+5, then I ought to be able to find bonds that pay X+5, no?
  - bogomipz 5y ago
    No. 30 year mortgages and 10 year treasuries move in unison but they are not the same rate. You can see this on the first graph here: https://www.thebalance.com/treasury-note-and-mortgage-rate-relationship-3305734 https://www.thebalance.com/treasury-note-and-mortgage-rate-r...
    - fshbbdssbbgdd 5y ago
      Treasuries are some of the lowest-yielding bonds out there.
      - bogomipz 5y ago
        Yes and treasures are the only bonds that move in lockstep with 30 year mortgages. When people talk about the correlation between bond yields and mortgages those are exactly the ones they are referring to. US Treasuries also are considered among the safest, least risky assets out there. This is true globally and has been for a very, very long time. This is all succinctly explained in the link I posted above. Lastly bond prices have an inverse relationship with interest rates, which means that as interest rates rise, bond prices go down. So no, when rates go up to x+5 you will never be able to find bonds that pay x+5.

AmericanChopper 5y ago

The value of all yielding assets is tied to interest rates. The risk free rate is a bench mark for measuring any type of return, so any time you change that you’re going to influence the valuation of everything. There’s also a very clear distinction between the idea of housing and home ownership. People need a place to live, they don’t need to have a property investment. You and I need healthcare, but neither of us need to own a hospital.