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Creditors take inflation into account when making loans. Only higher than expected inflation helps debtors. Lower than expected inflation hurts debtors. I'm

by rsj_hn 5y ago

Creditors take inflation into account when making loans. Only higher than expected inflation helps debtors. Lower than expected inflation hurts debtors. I'm not sure why you think Creditors would consistently underestimate inflation. Maybe they do, but why would they? One thing I am sure of, is that when inflation expectations change a lot so that there is a lot of doubt as to what future inflation will be, then creditors charge a higher premium for that perceived increase in inflation risk. That hurts debtors.

sokoloff 5y ago
What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house. The creditor who will ultimately hold that paper has a very different outlook on inflation rates than I do, but I’m happy to take the loan, especially since a side-effect is having a place to live.
- gruez 5y ago
  > What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house. that's canceled out by prices being higher because every other buyer has access to the same rates. Your monthly payments works out to be the same in the end because everybody bids up to the max they can afford.
- rsj_hn 5y ago
  > What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house [...] The creditor who will ultimately hold that paper has a very different outlook on inflation rates than I do, Such questions deserve answers. There is a lot that I skipped over, not wanting to get into the weeds of economic theory and start more arguments about whether the Fed controls rates or whether markets do (orthodox theory says markets control real rates and the fed only controls nominal rates, and thus inflation), and how savings demands respond to interest rates, and whether mortgages are risk free rates or not. All of that complicates the simple picture I painted, but I think that picture is basically correct. Suffice it to say that in terms of risk-free rates, the creditor's alternative is to buy a TIPS -- inflation protected bond -- which currently yields -1% https://www.cnbc.com/quotes/US10YTIP https://www.cnbc.com/quotes/US10YTIP So we are living in a very low interest rate world right now. Given that most likely your mortgage is government guaranteed (what mortgage isn't?) the entirety of the 3% you are paying is just as an inflation hedge plus some risk of pre-payment -- again, I have no idea what kind of points you have and the specific terms of the loan. If inflation was believed to be zero, you could probably get the same mortgage for less than 1%, maybe even 0%. We live in a world with very low real rates, but that does not mean that creditors don't take inflation risk into account.
  - sokoloff 5y ago
    > Suffice it to say that in terms of risk-free rates, the creditor's alternative is to buy a TIPS -- inflation protected bond -- which currently yields -1% TIPS have a yield that is referenced to the CPI (attempting to present a real yield), not a yield expressed in nominal dollars, so direct comparisons against mortgage rates (inherently nominal yield) are not very productive. The close equivalent to the 30YR mortgage rate is either the 10-year Treasury (currently yielding ~+1.6%) or, if you insist on matching maturities, the 30-year (currently yielding ~+2.0%) So, whatever risk premium the lender is demanding on a 0-points, 30-year fixed mortgage, it's a maximum of 1.4% (3.0%-1.6%). As a borrower, I'll happily take that deal.
- nradov 5y ago
  That 3% fixed interest rate isn't a real market rate. Most of those mortgages are purchased by Fannie Mae and Freddie Mac. Those companies are too big to fail and sponsored by the Federal government. If they went away then 30 fixed mortgages would barely even be available, or at least the interest rates would be far higher.
  - sokoloff 5y ago
    A jumbo loan (such as the quoted rate above from today for a $1MM mortgage) is not eligible for backing by Fannie Mae or Freddie Mac.
mrep 5y ago
> Creditors take inflation into account when making loans. How? I'm pretty sure that is determined by the market. 10 year treasuries are yielding 1.587% which is less than inflation and people still buy them because your alternative is cash with even worse returns.
jolux 5y ago
> I'm not sure why you think Creditors would consistently underestimate inflation. Maybe they do, but why would they? Hard to predict, in general. Would you have predicted we’d be looking at 5% inflation right now, three years ago? We haven’t seen inflation like this in decades. > That hurts debtors. Only if they have variable-rate loans. The broader point here is that it’s creditors (and the wealthy) who bemoan inflation the most because it means their rents are going to be worth less.
caeril 5y ago
> Creditors take inflation into account when making loans No, they do not, because they typically only hold the note for a few days before it gets securitized and sold onto a market that is pinned by a very large, inflation-agnostic player: The Fed. Now, we'll see what happens to this market if and when they begin to taper, but I think all the non-Fed players in this market remember what happened the last time they tried it, and they're all betting, correctly, that Powell will be forced into not only NOT tapering, but increasing purchases. All of these markets: treasuries, mortgages, auto loans, and junk bonds, know for a fact that there will always be an artificially high bid for their toilet paper. Why would they care?

by rsj_hn 5y ago

sokoloff 5y ago

What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house. The creditor who will ultimately hold that paper has a very different outlook on inflation rates than I do, but I’m happy to take the loan, especially since a side-effect is having a place to live.

gruez 5y ago
> What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house. that's canceled out by prices being higher because every other buyer has access to the same rates. Your monthly payments works out to be the same in the end because everybody bids up to the max they can afford.
rsj_hn 5y ago
> What you say makes logical sense, but is hard to square against the fact that, as a nobody, I can borrow $1M at under 3% fixed interest for 30 years to buy a house [...] The creditor who will ultimately hold that paper has a very different outlook on inflation rates than I do, Such questions deserve answers. There is a lot that I skipped over, not wanting to get into the weeds of economic theory and start more arguments about whether the Fed controls rates or whether markets do (orthodox theory says markets control real rates and the fed only controls nominal rates, and thus inflation), and how savings demands respond to interest rates, and whether mortgages are risk free rates or not. All of that complicates the simple picture I painted, but I think that picture is basically correct. Suffice it to say that in terms of risk-free rates, the creditor's alternative is to buy a TIPS -- inflation protected bond -- which currently yields -1% https://www.cnbc.com/quotes/US10YTIP https://www.cnbc.com/quotes/US10YTIP So we are living in a very low interest rate world right now. Given that most likely your mortgage is government guaranteed (what mortgage isn't?) the entirety of the 3% you are paying is just as an inflation hedge plus some risk of pre-payment -- again, I have no idea what kind of points you have and the specific terms of the loan. If inflation was believed to be zero, you could probably get the same mortgage for less than 1%, maybe even 0%. We live in a world with very low real rates, but that does not mean that creditors don't take inflation risk into account.
- sokoloff 5y ago
  > Suffice it to say that in terms of risk-free rates, the creditor's alternative is to buy a TIPS -- inflation protected bond -- which currently yields -1% TIPS have a yield that is referenced to the CPI (attempting to present a real yield), not a yield expressed in nominal dollars, so direct comparisons against mortgage rates (inherently nominal yield) are not very productive. The close equivalent to the 30YR mortgage rate is either the 10-year Treasury (currently yielding ~+1.6%) or, if you insist on matching maturities, the 30-year (currently yielding ~+2.0%) So, whatever risk premium the lender is demanding on a 0-points, 30-year fixed mortgage, it's a maximum of 1.4% (3.0%-1.6%). As a borrower, I'll happily take that deal.
nradov 5y ago
That 3% fixed interest rate isn't a real market rate. Most of those mortgages are purchased by Fannie Mae and Freddie Mac. Those companies are too big to fail and sponsored by the Federal government. If they went away then 30 fixed mortgages would barely even be available, or at least the interest rates would be far higher.
- sokoloff 5y ago
  A jumbo loan (such as the quoted rate above from today for a $1MM mortgage) is not eligible for backing by Fannie Mae or Freddie Mac.

mrep 5y ago

> Creditors take inflation into account when making loans. How? I'm pretty sure that is determined by the market. 10 year treasuries are yielding 1.587% which is less than inflation and people still buy them because your alternative is cash with even worse returns.

jolux 5y ago

> I'm not sure why you think Creditors would consistently underestimate inflation. Maybe they do, but why would they? Hard to predict, in general. Would you have predicted we’d be looking at 5% inflation right now, three years ago? We haven’t seen inflation like this in decades. > That hurts debtors. Only if they have variable-rate loans. The broader point here is that it’s creditors (and the wealthy) who bemoan inflation the most because it means their rents are going to be worth less.

caeril 5y ago

> Creditors take inflation into account when making loans No, they do not, because they typically only hold the note for a few days before it gets securitized and sold onto a market that is pinned by a very large, inflation-agnostic player: The Fed. Now, we'll see what happens to this market if and when they begin to taper, but I think all the non-Fed players in this market remember what happened the last time they tried it, and they're all betting, correctly, that Powell will be forced into not only NOT tapering, but increasing purchases. All of these markets: treasuries, mortgages, auto loans, and junk bonds, know for a fact that there will always be an artificially high bid for their toilet paper. Why would they care?