6 ms·

Maybe I'm not smart enough to understand what is going on here - is there any relevance to US markets (something tells me yes...)? and what is the TLDR if so (I

Maybe I'm not smart enough to understand what is going on here - is there any relevance to US markets (something tells me yes...)? and what is the TLDR if so (I suspect not good)?

burlesona 4y ago
The author is building an argument that central bank efforts to combat inflation will (unintentionally and unavoidably) drive inflation UP before they can bring inflation back down, essentially because the cost of housing represents such a large share of assets that mortgage rate increases will have a massive inflationary effect. I didn’t realize until reading the footnotes, but this is largely because in Canada you cannot get a fixed rate mortgage, only a 5 year ARM. So nearly everyone who has a mortgage will be forced to refinance at higher rates over the next five years, and those higher rates will greatly increase their cost of housing.
- papercrane 4y ago
  You can get long term fixed rate mortgages in Canada, but they're rare and the rates are high. The major in lenders don't typically bother advertising them, instead they advertise rates for 1-7 year term mortgages with various options (open/closed, fixed or APR.)
  - JohnJamesRambo 4y ago
    Why is this different in Canada and USA?
    - papercrane 4y ago
      I'm guessing regulatory frameworks and a more competitive market in the US. It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.
      - xuki 4y ago
        In the US the banks write the loans and offload them to Fannie and Freddie. It’s essentially a government back stop.
      - fennecfoxen 4y ago
        25? No one does 25. You’re locked in for 30.
        papercrane 4y ago
        You can only do 30 years in Canada if you put 20% down. The agency that underwrite default insurance will only insure up-to 25 year mortgages.
        dghlsakjg 4y ago
        25 is the standard in Canada.
      - kelnos 4y ago
        There's actually minimal risk to the bank; 30-year fixed mortgages are guaranteed by Fannie and Freddie, who are guaranteed by the US government. If a borrower defaults, the US government makes the bank whole again. Banks do pay for the privilege, but it's pretty much always worth it to them.
        SilasX 4y ago
        What are you referring to by banks paying for the privilege? Like an fee they have to pay to be able to offload into Fannie? Or compliance costs? Or something else?
      - throwawaymaths 4y ago
        It's even surrealer to me that my mother got a 30 year mortgage. She's 80. While I think she has an outside chance of living till 110 - she has really good genetics - I doubt the bank knows this... I'm not exactly sure what the plan is (though she is good for the payments so long as she lives).
    - kelnos 4y ago
      I was having a back-and-forth on HN a while ago with someone who knows more about this, and learned why! It's because of Fannie and Freddie. They're in the business of guaranteeing mortgages in the US, and the US government in turn guarantees Fannie and Freddie (this is why they still exist post-2008 and weren't completely obliterated in the financial crisis, as they should have been). And it turns out that Fannie and Freddie will not back loans that involve balloon payments. Banks want to make loans that Fannie and Freddie will back, because that basically takes away all their risk. To figure out why this is a problem for shorter loan terms, we have to look at monthly mortgage payments. Here's what US fixed mortgages look like right now (quick glance at bankrate.com), with monthly payments assuming you're taking a $500k loan: Term Rate Payment 30Y 5.54% $2850 15Y 4.75% $3890 10Y 4.67% $5220 Two things to note: 1. As the term drops, the interest rate does not drop proportionally. 30Y -> 15Y is a 50% drop in term, but only a 14% drop in interest rate. 15Y -> 10Y is a 33% drop in term, but only a tiny 1.6% drop in interest rate. 2. Look at how those monthly payments go up! And we've only gone down to a 10Y term, whereas, from what I understand, Canada's look more like 5Y. So even if we're "generous", and say that going from 10Y to 5Y gives you an interest rate of 4.25%, your monthly payment goes up to around $9260! How many people in the US could afford a $9k monthly mortgage payment on a $625k home (assuming 20% down payment, which is standard in the US)? Canada solves this with a balloon payment. If you're Canadian I assume you know this already, but for everyone else: essentially, for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above. And then, near the end of the loan term, you make up for it with a giant "balloon" payment. Americans are conditioned to think this is scary, but in practice, what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term. (I've gotten this from a random discussion on HN, not my own research, so please correct me if I've gotten anything wrong here.) And, as I said, this can't work in the US because Fannie and Freddie won't back loans that include balloon payments, so banks don't generally offer them. Many do offer 15Y and 10Y fixed-rate mortgages, but they have much higher monthly payments, so most borrowers stick with the 30Y mortgage, especially when interest rates are at their lowest, like they have been for the past decade+. The alternative in the US is the adjustable-rate mortgage (ARM), usually offered as a 5/1 or 7/1. It's a 30-year mortgage where you get a fixed rate for 5 (or 7) years, and then your rate is adjusted to market rates every year for the next 25 (or 23) years. The interest rates are even lower; for example, the 5/1 ARM is at 3.91% right now, so the monthly payment ($2360 for our $500k loan) is lower than even the 30Y fixed. But many people view them as risky, and like the comfort in knowing that their interest rate will be locked in for 30 years, even if it's a little higher. Given that rates are going up now, though, I expect ARMs will become more popular, as people will predict/hope that rates will be lower in 5 (or 7) years, and they can refinance with a 30Y fixed -- or another ARM, if rates haven't gone down much, or, worse, have gone up.
    - ska 4y ago
      US government mostly takes on the risk; Canadian government doesn't.
    - neilwilson 4y ago
      Who takes the floating side of the fix risk? In the USA there are statutory bodies that do that. In a free market there would be no liquidity.
- bombcar 4y ago
  Which is a huge difference from the US, where if rates are rising fast, the current homeowners are more likely to decide to not move.

Maybe I'm not smart enough to understand what is going on here - is there any relevance to US markets (something tells me yes...)? and what is the TLDR if so (I suspect not good)?

burlesona 4y ago

The author is building an argument that central bank efforts to combat inflation will (unintentionally and unavoidably) drive inflation UP before they can bring inflation back down, essentially because the cost of housing represents such a large share of assets that mortgage rate increases will have a massive inflationary effect. I didn’t realize until reading the footnotes, but this is largely because in Canada you cannot get a fixed rate mortgage, only a 5 year ARM. So nearly everyone who has a mortgage will be forced to refinance at higher rates over the next five years, and those higher rates will greatly increase their cost of housing.

papercrane 4y ago
You can get long term fixed rate mortgages in Canada, but they're rare and the rates are high. The major in lenders don't typically bother advertising them, instead they advertise rates for 1-7 year term mortgages with various options (open/closed, fixed or APR.)
- JohnJamesRambo 4y ago
  Why is this different in Canada and USA?
  - papercrane 4y ago
    I'm guessing regulatory frameworks and a more competitive market in the US. It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.
    - xuki 4y ago
      In the US the banks write the loans and offload them to Fannie and Freddie. It’s essentially a government back stop.
    - fennecfoxen 4y ago
      25? No one does 25. You’re locked in for 30.
      - papercrane 4y ago
        You can only do 30 years in Canada if you put 20% down. The agency that underwrite default insurance will only insure up-to 25 year mortgages.
      - dghlsakjg 4y ago
        25 is the standard in Canada.
    - kelnos 4y ago
      There's actually minimal risk to the bank; 30-year fixed mortgages are guaranteed by Fannie and Freddie, who are guaranteed by the US government. If a borrower defaults, the US government makes the bank whole again. Banks do pay for the privilege, but it's pretty much always worth it to them.
      - SilasX 4y ago
        What are you referring to by banks paying for the privilege? Like an fee they have to pay to be able to offload into Fannie? Or compliance costs? Or something else?
    - throwawaymaths 4y ago
      It's even surrealer to me that my mother got a 30 year mortgage. She's 80. While I think she has an outside chance of living till 110 - she has really good genetics - I doubt the bank knows this... I'm not exactly sure what the plan is (though she is good for the payments so long as she lives).
  - kelnos 4y ago
    I was having a back-and-forth on HN a while ago with someone who knows more about this, and learned why! It's because of Fannie and Freddie. They're in the business of guaranteeing mortgages in the US, and the US government in turn guarantees Fannie and Freddie (this is why they still exist post-2008 and weren't completely obliterated in the financial crisis, as they should have been). And it turns out that Fannie and Freddie will not back loans that involve balloon payments. Banks want to make loans that Fannie and Freddie will back, because that basically takes away all their risk. To figure out why this is a problem for shorter loan terms, we have to look at monthly mortgage payments. Here's what US fixed mortgages look like right now (quick glance at bankrate.com), with monthly payments assuming you're taking a $500k loan: Term Rate Payment 30Y 5.54% $2850 15Y 4.75% $3890 10Y 4.67% $5220 Two things to note: 1. As the term drops, the interest rate does not drop proportionally. 30Y -> 15Y is a 50% drop in term, but only a 14% drop in interest rate. 15Y -> 10Y is a 33% drop in term, but only a tiny 1.6% drop in interest rate. 2. Look at how those monthly payments go up! And we've only gone down to a 10Y term, whereas, from what I understand, Canada's look more like 5Y. So even if we're "generous", and say that going from 10Y to 5Y gives you an interest rate of 4.25%, your monthly payment goes up to around $9260! How many people in the US could afford a $9k monthly mortgage payment on a $625k home (assuming 20% down payment, which is standard in the US)? Canada solves this with a balloon payment. If you're Canadian I assume you know this already, but for everyone else: essentially, for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above. And then, near the end of the loan term, you make up for it with a giant "balloon" payment. Americans are conditioned to think this is scary, but in practice, what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term. (I've gotten this from a random discussion on HN, not my own research, so please correct me if I've gotten anything wrong here.) And, as I said, this can't work in the US because Fannie and Freddie won't back loans that include balloon payments, so banks don't generally offer them. Many do offer 15Y and 10Y fixed-rate mortgages, but they have much higher monthly payments, so most borrowers stick with the 30Y mortgage, especially when interest rates are at their lowest, like they have been for the past decade+. The alternative in the US is the adjustable-rate mortgage (ARM), usually offered as a 5/1 or 7/1. It's a 30-year mortgage where you get a fixed rate for 5 (or 7) years, and then your rate is adjusted to market rates every year for the next 25 (or 23) years. The interest rates are even lower; for example, the 5/1 ARM is at 3.91% right now, so the monthly payment ($2360 for our $500k loan) is lower than even the 30Y fixed. But many people view them as risky, and like the comfort in knowing that their interest rate will be locked in for 30 years, even if it's a little higher. Given that rates are going up now, though, I expect ARMs will become more popular, as people will predict/hope that rates will be lower in 5 (or 7) years, and they can refinance with a 30Y fixed -- or another ARM, if rates haven't gone down much, or, worse, have gone up.
  - ska 4y ago
    US government mostly takes on the risk; Canadian government doesn't.
  - neilwilson 4y ago
    Who takes the floating side of the fix risk? In the USA there are statutory bodies that do that. In a free market there would be no liquidity.
bombcar 4y ago
Which is a huge difference from the US, where if rates are rising fast, the current homeowners are more likely to decide to not move.