The Case for Higher Interest Rates and Lower Home Prices 28 comments
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With the continual prodding by many to initiate 4.5% mortgage rates to pacify the current housing market glut, it's important to distinguish the effects based on two categories of buyers:
- Existing mortgage refinancing
- Home Purchase Mortgages
Fundamentally, the problem with this policy is that it is likely to have a minimal effect on latter category. Saskia Scholtes wrote about this in "Mortgage activity surges at US banks":
With average rates for a 30-year, fixed-rate mortgage now at about 5.2 per cent, growing numbers of borrowers have an incentive to refinance to bring down their mortgage costs. But tighter underwriting standards for prospective borrowers, combined with funding and staffing difficulties for mortgage originators, are likely to restrict the supply of new mortgages.
It's clear that rates falling to 4.5% would stimulate mortgage refinancing, but not new mortgage approvals. Everyone from my father-in-law to our data clients at Altos Research have consistently pointed out the merits of such action. If you're paying 6% or even 5.5%, if would naturally be in your personal financial interest in the long run to refinance to a lower rate.
However, Scholtes' article indicates exactly what I've been talking about - that lowering mortgage rates will not significantly stimulate housing demand. Here's an example of what I mean:
What if we kept mortgage rates at 5.5% to compensate lenders for lending risk, but awaited a continued aggregate home price decline?
Using Mortgagecalculator.org, I ran the numbers based on a $300,000 home price and a $240,000 loan (though I'm not sure someone buying a $300,000 house will have $60,000 to put down to cover the 20% down payment requirement, but this is an experiment).
At a 5.5% rate, the monthly payments are $1,712.69. At a 4.5% rate, the monthly payments fall by $146.65 to $1,566.04. The move from 5.5% to 4.5% is a drop of 18%.
Now what if home prices fell 18% from $300,000 to $246,000 (a decrease of $54,000) but mortgage rates stayed at 5.5%? Assuming the same 20% down payment, the loan amount would be $196,800 for a home priced at $246,000 and the monthly mortgage payment would be $1,404.41 - a drop in the monthly payments of $308.28. Which would stimulate demand more - lowering the monthly payments by $146 or $308? Lower mortgage rates will lead to lower housing prices as viewed by the buyer (in terms of monthly payments), but not by as much as lower home prices.
Yes, I realize that this is blasphemy because I'm advocating unchanged mortgage rates and a continued fall in home prices. However, the net gain is that lenders can lend to more borrowers at the higher rate. Why? Because the extra 1.0% offers a risk premium to lenders that will enable lenders to account for the riskiness of the buyers (we don't pay our bills here in America), thus increasing the number of buyers that would quality for approval. Additionally, a decrease in home prices would lower the income requirements for approval for buyers of this same risk profile. At a lower interest rate (say 4.5%), lenders will be forced to maintain stringent mortgage approval guidelines and the lower rates would have less effect on a buyer's monthly mortgage payments.
Remember - it was cheap money to unqualified buyers that bears considerable responsible for the housing price mess in the first place.
The counter to this argument is simple - if home prices continue to fall, the number of "walkaways" will increase because more current home owners will be under water in their existing mortgages. This brings us back to why advocates of the 4.5% mortgage rates feel this is a viable proposal to solve the housing problem - these homeowners will be more likely to refinance than walkaway.
I'm not so sure about that. Using same figures above, will a homeowner that's avoiding the $1712 payment above suddenly begin making payments if at $1566? Probably not. Check out the latest data on loan modification application-to-approval rates with the number of interest-only loans creating first and second-lien situations.
Stock position: None.
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This article has 28 comments:
If you don't have 60K to your name to put down on your house, how can you actually claim to be a real estate expert? 'Experts' like yourself have help create our problems and should be ashamed to publish such drivel.
But a very clear insight. The best thing for the housing market is for prices to fall. Lower prices are better for first-time buyers, better for homeowners with little equity and better for homeowners with significant equity in their homes.
1) First-time buyers - the benefits are pretty obvious here. Pay less and get more house.
2) Homeowners with little equity - they can walk away from their mortgage, rent for a few years while saving money and then they enjoy the same benefits as first-time buyers.
3) Homeowners with significant equity - if you stay in your home your mortgage doesn't change, you still have the same house and nothing changes. If you want to move, the equity you bring to your new home will remain the same relative to your new home since the price of your new home will have shrunk.
The best part of this solution is that it requires no additional government or central bank intervention and no additional taxpayer liabilities. Unfortunately this will not be seen as a good thing to politicians and bureaucrats or to a great portion of the electorate who do not realize that money spent by the government comes only from the taxpayer.
however, to get that home to 240k, the current mortgagee at 280k will have to take a real big haircut; if the mortgagee is a bank with only 10 cents per dollar in the game, the drop in house value to 240k would wipe out all the capital at the bank --- closing citi, bankamerica, and a whole bunch of others.
the finesse that's needed here is to save a few of these banks
a 1% change in rates ... using your example....is an 8.5% change in payment...for purposes of easy calculation...1% change in rates affects the the cost of housing by a (rounded) factor of 10%....
so, using your example, and doing the math....the housing cost would change 10.8%.....Not 18.2%
Take a $300,000 home mortgage at 4.5%, that pays $1,520.06 monthly...
And the same payment at 5.5% (41,520.06) generates a mortgage amount of $267,715.65......not $246,000
I agree that rates do not need to go down to stimulate houing....low rates reflect a corpse of an economy....market driven increasing rates indicates health and vibrance....
We need to get back to a true market in houisng...if possible.....one where buyers and sellers make deals...
For 15+ years, the lending community (frrom the top...GSE's/Congress/R... Street... manipulated the credit process and distorted housing values.....
Now the same group is manipulating the market value of housing by dumping and running away from the scene of the crime....
Would lenders, without bailout money, be so quick to discount REO's ....
Would lenders, without bailout money to pay bills...run from their primary business of LENDING MONEY?????
tankthebank.com
www.zeitgeistmovie.com
Prices have to fall as a natural cleansing process. Those who cannot afford property should not have been encouraged to buy in the first place. Reality always has a way of catching up. Playing God with interest rates only encourages further malinvestment; unfortunately, we're at a precipice where more dislocation from stability could mean disaster.
I'd rather suffer asset price decline now instead of total financial system collapse later, with our currency rendered worthless and our government unable to meet debt service requirements.
Balabanovj
Let the market decide the price, interest rate, and down payment requirements. Or have you all led such cushy soft lives that you can't stand the thought of a few years of pain?
Nobody should be raising or lowering rates or home prices. When you fool with market forces they snap back and bite you in the rear end. Too bad they don't teach common sense in business schools.
,
On Dec 25 10:42 AM D. McHattie wrote:
> Blasphemy!
>
> But a very clear insight. The best thing for the housing market is
> for prices to fall. Lower prices are better for first-time buyers,
> better for homeowners with little equity and better for homeowners
> with significant equity in their homes.
>
> 1) First-time buyers - the benefits are pretty obvious here. Pay
> less and get more house.
>
> 2) Homeowners with little equity - they can walk away from their
> mortgage, rent for a few years while saving money and then they enjoy
> the same benefits as first-time buyers.
>
> 3) Homeowners with significant equity - if you stay in your home
> your mortgage doesn't change, you still have the same house and nothing
> changes. If you want to move, the equity you bring to your new home
> will remain the same relative to your new home since the price of
> your new home will have shrunk.
>
> The best part of this solution is that it requires no additional
> government or central bank intervention and no additional taxpayer
> liabilities. Unfortunately this will not be seen as a good thing
> to politicians and bureaucrats or to a great portion of the electorate
> who do not realize that money spent by the government comes only
> from the taxpayer.
The govd. can make things worse but cant help the problem. Only the market can cure the problem. It will be painful but pain is the only way. Housing prices must come down. The smart will walk away if they owe much more then what the house is worth.
On Dec 25 11:57 AM Rob Viglione wrote:
> @Bob N, why the harsh words? No need for that kind of negativity.
> This article makes perfect sense. You don't have to be a real estate
> "expert" to understand that prices have meaning and markets have
> natural mechanisms for rewarding the prudent and levying consequences
> upon the imprudent.
>
> Prices have to fall as a natural cleansing process. Those who cannot
> afford property should not have been encouraged to buy in the first
> place. Reality always has a way of catching up. Playing God with
> interest rates only encourages further malinvestment; unfortunately,
> we're at a precipice where more dislocation from stability could
> mean disaster.
>
> I'd rather suffer asset price decline now instead of total financial
> system collapse later, with our currency rendered worthless and our
> government unable to meet debt service requirements.
it is excess leverage, permitted by the regulatory agents of the financial system...primarily the federal reserve whose job it is to safeguard the system, a task at which it utterly failed.....and secondarily the congress that is the absolute cause of this financial debacle...period. nothing else remotely matters....not high interest rates, not bubble-style home prices and not recession.
there is no free lunch. people who think 5 1/2 percent mortgage rates are a "problem" are utterly out of their minds. they aren't. they represent the lowest long term financing cost of residential housing in at least two generations. if that's not enough to stimulate the market it speaks for itself....houses are still overpriced.
what fries my ass is that the morons in charge of our financial system are using the same dysfunctional policies to try to rescue it. they are wrong and they will fail.
take it to the bank.
anytime soon as it has been. Even in a Repro now you will have to have to qualify for a mortgage to get into a house. Our overstock and oversupply will only last so long and after that you will have to pay big bucks to have your own home. The builders will not provide a free for all
a second time...MarvinMBA
This article is spot on. Its only blasphemy to morons.
I'd go so far as to say that in our so called capitalist system, the price of capital should be set by the market. Bye bye, Federal Reserve, you won't be missed. Don't let the door nob hit you where the dog should have bit you.
20%-25% down, 15-30 year mortgages = stable home market and no bubbles. Very unhealthy to create real estate bubbles- it is one of the essential human needs along with food and energy.
We can now see where financial and tax shelter gimmicks get us. They not only damage the buyer for years, but trickle the massive damage into the entire economy for years. Another product of 0% and gimmick loans is
over building. The overbuilt areas now get rewarded with years of stagnant
prices, yet another end result of the pyramid concept. Of course local government can't complain- the goal was to "inflate" property taxes via
higher assessments, so mission accomplished.
As user110015 said- ownership is not for everyone. Taxes , insurance, utilities, maintenance- they add significant burden to the equation these days, so low equity buyers are far better off to rent and save money.
I'll be curious to see where real estate prices correct to? Pre bubble (1998?) + cost of inflation for 10 years? We have a ways to go if we are going back to historic lending standards. From every angle this "appears" to be a long and painful correction with lots of homeowners better off bailing out.
When our good pals Reagon, Clinton, and Bush Jr started the de-regulation
process with lots of help from Uncle Al Greenspan, years later this is the end
game- best to keep a watchful eye on our banker and financial experts.
All roads lead to stagflation imo.
Anyone else have an opinion about this?
OwnerFinanceGuru.com
So, they do the next best thing - lower rates in the blind hope that it will work. America is after all addicted to the monthly payment plan. My worry is that lowering rates still won't let the underwater homeowner refinance, but at least the public at large is a bit more content.
On Dec 25 10:55 AM L Boyd wrote:
> Exactly; simply put, we had an era of easy money which naturally
> led to inflated prices - across all asset classes - though real estate
> was the go to. Asset prices have to come down, there is simply no
> way around it. I don't care if the government gives money away (they
> seem to have no problem with that), it won't solve the problem. The
> only cure is a general lowering of prices - many people will lose
> money, yes, but this is the reality of it. Better to accept it now,
> and move on.
Yes, I know it's painful for people who bought too high, but that doesn't affect the real facts: the houses were overpriced compared to income. Housing will not stabilize until the bubble is worked off. Schemes to keep the bubble inflated will just stretch it out.
The american dream is made of of land materials and labor and they have bottoms in their current values; therefore ,the bottom in the the housing market will not continue for long with home prices lower then the combination of the ingredients that make the home.
Poor underwriting due to radical goverment regulation and goverment greed by adding all kinds of fees, tax and conditions adding to closing costs on the backs of homebuyers is the root cause of the housing
Interest rates should be based upon risk and cost of money delivery in a competive market
Underwriting should be seperated from the lending banks
Mortgages originators are the borrowers so why is their an origination fee?
.
Rates should go lower because of the nature of the capital markets. Gov't bonds are nearly 0%, because we're in a deflationary environment. Thus, shouldn't mortgages rate have a 3-4% spread on top of that if you add in credit risk?