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phkahler

Home prices vary inversely with interest rates. Here's how that works:

1) person tells bank they'd like a mortgage to buy a house.

2) banker asks for info on income, expenses, etc.

3) banker estimates persons maximum monthly payment.

4) banker figures out max loan amount based on #3

5) buyer is encouraged by everyone to spend the full amount from #4

Everyone - the seller, their agent, your agent, the bank, and maybe some others - want you to spend every penny you can. Everyone benefits from higher prices except the buyer. Even if you're immune to it, there is enough pressure that the market as a whole tends toward the highest prices people can afford.

Now lets see how interest rates play in this. At step 4 above, the amount you can borrow for a given monthly payment is mathematically increased by lower interest rates. For a given amount of debt your payment should be lower if rates are lower - that's true - but they'll make up for it by pushing a larger loan.

Ultimately your payment is determined in step 3 and has nothing to do with interest rates or home prices. You will "pay" the same for your house (total payments) regardless of interest rates. The only thing the interest rate determines is who gets the money - the seller or the bank.

In a services and consumption based economy this is the primary way interest rates drive things. Sure, businesses will do their part too, but they're a smaller part of it.

View on HN

I expected this was true for the same reasoning when buying a home, but when I sampled the historical numbers, there was no strong relationship.

Bankrate came to similar conclusions: https://www.bankrate.com/finance/mortgages/rising-rates-lowe...

I think your reasoning is valid, so best I can figure it's because home prices and interest rates are both directly correlated with economic activity. So if the economy is heating up, that might drive up wages and interest rates and inflation, and you see interest rates and home prices go up in parallel.

The model of two simple variables tugging on each other breaks down when you add other factors, hence the weak relationship.

Lowering interest rates increase prices. Rising interest rates reduce volume until inflation catches up. People are unwilling to sell homes when they lose value because there is so much leverage

Up until they have no choice but to sell, and in that case, have to sell at any cost.

I don't believe your analysis. The relationship has such a high correlation, you can just look at the the graph and probably eyeball estimate the regression within 10% error.

Banks and relators have such a massive conflict of interest in pretending that the inflated prices on housing are normal. Rising interest rates are causing housing sales volumes to plummet to record lows, and after over a year of pretending nothing was wrong, prices are finally starting to come down.

But the people invested in the housing market want to pretend it's anything other than the interest rate, like a child caught with their hand in the cookie jar and making up nonsensical explanations on why it happened.

When I eyeball the graph, 2002 to 2011 really jumps out. For about a third of the graph the two move in lock step.

It's a weird sort of inverted relationship when the variables spend so much time moving in the same direction.

Here's another take:

“If you look at the relationship between [mortgage] rates and [home] sales and home prices, the relationship is almost zero,” said Sam Khater, deputy chief economist at CoreLogic.

https://www.curbed.com/2018/2/20/17029746/interest-rates-ris...

Maybe all these people are biased, or lying about simple numbers, or it's some big conspiracy.

The alternative explanation is just that the economy really has more than two variables.

That second hypothesis doesn't seem so preposterous to me.

Indeed. It's worth considering as well that even when analyzing actual data what seems like a relationship between two variables can be wiped out or inverted by the addition of other variables into the model. It's important to include all relevant variables into the model to know how two variables really interact.

There is no conspiracy, just that the rules changes to keep demand going.

All sorts of garbage loans that would have been illegal in the past are now common.

Close! The Fed printed many more dollars. Society gradually learns to revalue things and it starts with assets. The same reason Bitcoin and liquid assets are falling, the Feds destroying dollars. It's not that these things are falling but that USD are becoming more scarce.

I don't understand how that would work. Are you saying the fed printing money has meant that things like Bitcoint have gone done in value? Shouldn't it be the opposite since there's more or less a fixed supply of Bitcoin?

Or are you saying that Bitcoin went up because they printed money and is now falling again as people get used to the increased monetary supply? That doesn't make sense to me either as I've never heard of an effect like that before

I'm saying this one,

> Or are you saying that Bitcoin went up because they printed money and is now falling again as people get used to the increased monetary supply

It's pretty amazing, but it's true. The Fed can alter the countable Dollars in existence ("money supply"). They have a gov granted monopoly on 'em.

Yah this is ridiculous - 99% of the price change in bitcoin is entirely unrelated to the money supply. At most 1% and almost certainly significantly less is related to it. Bitcoin's price change is due to speculation plain and simple.

There is a good amount of what's posted here about the financial system that is true, and a good bunch isn't.

Bitcoin has gone up thousands of percent in a few years, gold has barely moved. Trying to claim Bitcoin's movement is due to money supply reasons makes zero space.

But stocks have gone down considerably also. There are many things that cause volatility in crypto, but bear in mind stocks lost more than 2 trillion dollars in october. Several times the entire "market cap" of BTC.

Almooooooost

The fed printing more dollars is done in a way designed to push people into riskier products.

The literal point is so that people put their money into the economy instead of parking it in a savings account. So even though your favorite personal finance guru is having you celebrate 1.75% in an Allied Savings account in exchange for referral commissions, the point is for that to be an unattractive use of your money.

Basically the fed buys things in exchange for dollars that didnt previously exist. Asset goes on the Fed’s balance sheet, the dollars are in the prior owners pockets.

The fed predominantly buys US treasuries, from both the secondary market and directly from the US Treasury.

When you buy these you are picking them up at a higher price than the last person, and this lowers the return you can get from the treasuries. The US government treasury bonds being the safest assets by guarantee of getting your money back. When you cant tolerate that yield anymore, you buy higher yielding assets that are less safe. The fed bought the whole yield curve, pushing people to buy more municipal bonds, corporate bonds, junk bonds, stocks, private equity funding startups, houses

The whole point is to push people to make their money circulate in the economy

Yes the market decided that bitcoin and cryptocurrency would give them ROI, after every socioeconomic class figurd out that houses and stocks are too overpriced to make sense

Why not crypto? Okay now that went further than demand would tolerate

And as risk off mentality comes back, and as other assets lower on the yield & risk curve come back into better lower pricing, people will likely find them attractive again because they are safer and you’ll also get your 5% annually with no work

Okay, so you mention what the Fed buys, but what does it sell? The same stuff, right? Assets. Assets become less scarce (Fed sells), prices go down. At the same time, Dollars become more scarce as the Fed sells their assets.

I was with you until you mentioned crypto in the same sentence as market forces, as if the price of bitcoin or any other crypto currency is due to any factor other than rampant speculation (or blatant price manipulation). At this point, I look at die-hard crypto converts the same as evangelical Christians. Not that either are bad, they just believe in made up things.

I genuinely wonder if even the whole financial market is driven by people who believe in made up things and that it doesn't really matter as long as everybody keeps believing in it

my whole post described how cryptocurrencies are the tail end of rampant speculation as it is further out on the risk curve and that there is an irony as this isn't what the monetary policy distortions were intended to do, check yourself.

I’d dig deeper. Buying power is a zero sum game driven by price, interest and tax.

When you look at tax rates, there’s a direct correlation between home price and taxes in high price states like NY, that correlates tightly with the impact on buying power.

I’d guarantee that if you were looking at the 11% 30-year mortgages with 85% LTV requirements that were typical in the 1980s, prices would be very close to 1980 levels adjusted for inflation.

> Ultimately your payment is determined in step 3 and has nothing to do with interest rates.

This presumes a single purchase. You've got to go 'macro economic' to see where this breaks down.

When prices start rising because of increased max loan amounts, you get things like bidding wars. Toronto has been terrible for those in the last 5 years. Both the bank and the seller win when people start paying (and borrowing) twice as much as they would have for the same house 5 years ago. Belief that home values are higher and will rise causes them to do so (bubbles, yay).

Example, personal: I bought my condo for under $600k 3.5 years ago. The neighbour is selling their nearly identical one today for just shy of $1m. (CAD$, but still insane). Interest rates are higher today than they were when I bought.

My new neighbours will pay higher amounts to both the bank and the seller. There's more to prices than just interest rates.

However, the problem is that loans are an extrapolation of 30 years of income. So in a boom portion of the cycle, we over project an unsustainable income but in the bust portion, we under project. There is an inherit recency bias in the loan approval process.

When coupled with an interest rates that are far below the historical median, there is an implication that a buyer can take out more debt than in any other economic conditions.

This is a great resource to understand macroeconomic debt cycles: https://www.youtube.com/watch?v=PHe0bXAIuk0

However in a place like Toronto, I imagine there could be a lots of regional factor that would be more significant than interest rates: - Gentrification - Zoning Restrictions - Increase in Population - Geographic constraints (like bridges, freeways, school districts)

Personally, I suspect you'll do quite well in Toronto but every housing market faces headwinds at some point.

And on the flip side, you can assume some level of inflation which makes that 30 year bet on your income less crazy. Sure, I don't expect to make 200k+ in inflation adjusted dollars for 30 years, but I might make that much after inflation devalues the dollar.

I'm guessing you're in Toronto or Downtown Vancouver, mind breaking down approximately where/what your condo is out of curiosity? I'll never hope to own something here, but I'm always curious how far out these insane prices are getting and what you would get for 1m.

Toronto. We're double engineer income with no kids, and spent years saving up. We were also fortunate in finding this place, the unicorn of condos: 1400 sqft, near a subway station, well-built building, responsibly managed condo board.

Is it worth $1m? Oh heck no. I don't think it's worth what we paid even, once the market readjusts to reality.

Damn. That certainly is a unicorn. Congrats on finding it.

Until the music stops. See how much those condo's sell for during the next downturn, if you can even sell them.

If interest rates go up causing people not to be able to afford their payments, those condos will sell -- after the mortgages have been foreclosed. Was in London in 1992, just before the pound was removed from the European exchange rate mechanism. Very instructive.

Now is a particularly dangerous time to overextend yourself on a mortgage. For any realistic scenario, interest rates will never be lower than they are now. People ridiculously short terms on their mortgages (like 5 years or less). On top of that they are encouraged to take floating rates to shave a little bit off. If you end up with $1 million in debt and the interest rate jumps up to 5% (or 10%... or like London at the time I was there -- 18%!) what will you do? Of course you will have no choice but to default on your loan. House goes into a fire sale, but nobody can afford it with the higher rates, so it's sold for 10% or 20% or even 30% less than the original mortgage... And now, that's the price of houses -- Virtually everybody is more than $100K underwater at that point meaning that if you miss a payment, personal bankruptcy is probably your only hope.

Of course, it may not happen in our life times. That's the tricky bit.

Does anyone get floating rate mortgages any more?

I thought (could be very wrong) that these had mostly gone the way of the dodo due to exactly what you're describing.

In Canada, most mortgages have to have their rate renegotiated every few years. For example, mine was amortized over 30 years, but on a five year rate. When five years are up, I have to renegotiate an interest rate. "Renewing" the mortgage.

This has interesting properties economically. It's a bit like a floating rate in that it will change, but like a fixed rate in that you don't have to worry about next month having an unexpected high bill. The banks give better rates because they only have to estimate the near-future and not the next 30 years.

Big question: what happens when all the people who could barely afford their mortgage five years ago come to renew with rates higher?

In Canada, you have the option of taking a fixed rate or variable rate mortgage, with the latter offering a more attractive rate (for example 3-year fixed was 3.14% while 3-year variable was 2.85%).

You can roll the dice on increasing interest rates but I locked in on a fixed rate because I knew the rates would be going up 3-4 more times in the next 3 years.

It's crazy how this isn't more common knowledge that the Economist needs to write an article about it. We're also seeing the same thing recently with tuition prices. There is more money available for student loans so schools just jack up the tuition to meet the supply of money available.

That’s not just a question of loans. Schools can always discount prices down to what people can pay. So, they charge families making twice as much more money each year.

It's insane what schools can get away with for price discrimination.

Remember the uproar over Orbitz (and others) price discrimination based on Mac/iOS usage? [1]

Schools have been doing the same thing in broad daylight for years and years with far greater consequence, basing their price on your parent's income levels.*

And near zero public blowback. It's confusing.

* This is all done through school scholarships, but there's practical difference between that and a more direct price adjustment.

[1] https://www.wsj.com/articles/SB10001424052702304458604577488...

It’s an informal social program. The rich subsidize everyone else.

Not so much the rich as like social security the cost caps out fairly low. Save on the low end ~100$ to high end ~500$ a month from birth and collage is mostly paid for via compound interest. That’s expensive, but students with 100+k in debt mostly don’t go to affordable schools.

> ~500$ a month from birth

That is literally half my mortgage. For a single child. For years.

> And near zero public blowback. It's confusing.

It seems like there should be a market opportunity for an above-median school that charges below-median tuition by just charging everyone the same amount, and then picking up slews of high quality middle class students.

I suspect what's preventing it is the state universities. The states with large middle class populations also generally have above-median state schools with below-median tuition for in-state students, so the market is already served and the public universities out-compete the private ones without an existing endowment because they're subsidized with public money.

It's also quite unfortunate because it locks everyone into the university of their own state, so they don't really have to compete with each other and the students in a state with a poor quality state university get the shaft.

What the states could do to improve this is to separate "in-state tuition" from the state university -- if you qualify for in-state tuition then you get that much money toward your tuition no matter which school you attend. It would probably devastate the state universities (because they wouldn't be competitive if people had that choice), but if the replacement would be better and cost less...

When we're isolated and not shown the schematic of how money is distributed, incoming and outgoing - and it's planned complexity like planned obsolescence, a subtle yet powerful design - it is a purposeful state of chaos/confusion created that leads to something similar to, if not the same, as decision fatigue (and in most cases this would require a lot of individual research to understand the underlying structures); you either don't understand and buy into it out of necessity (you need a place to live, you need education), and you either can afford it or not (loan), or you don't understand and don't buy into it because you don't understand or can't afford it - but then you can't move forward in life, at least not in as comforting as a way the path that "everyone" is seemingly following, or at least that indoctrinated systems and structured paths, industrial complexes, and marketing/advertising tells us "everyone" is doing and are important to do/solves a problem for us.

Society needs to decide that we want transparency, accountability/accounting, and I believe we need to focus on promoting a unit cost structure, so people can see the full relative cost; what are the different models, what ecosystems/cities are using which model, and how can I "vote" for that system model by spending/buying into the model that I want to be perpetuated?

Why isn't there any public blowback regarding unequal pricing for public goods and services? They are mostly funded from income taxes which are not proportional to the amount of service thr payer gets at all.

Property taxes would actually be different. The more you own, the bigger the effort the state has to gear towards you to guarantee you your ownership. Laws, law enforcement, judges, fire department in case it catches fire etc.

Income taxes are the largest most discriminating schemes ever.

IDK about "any public blowback"...income tax was and is very unpopular.

It took an entire constitutional amendment before it was adopted in the U.S.

imho the only way to correct the cost of higher education is to limit what the federal government will loan per credit hour by course. many don't seem to have a problem with government dictating how much a medical procedure will be paid so lets apply that to education.

you can damn well bet you will entire degrees built around the limits if they were in place. put it down to this course is worth X per credit and this degree is worth X amount and requires a set of course credits that will have loan money available.

as to the article in question, one variable was missing. buyers won't accept homes and features that they can easily afford but are influenced by TV and other forms of marketing let alone the old keeping up with the Jones

I read an article where they did a supply/demand analysis of tuitions, and found that tuitions might simply be responding to demand. Obviously, there are a lot of factors to consider. But they looked at broader economics for demand (jobs, unemployment) and existing college sizes (instructor and class volume) and found that pricing were correlated with supply/demand changes, with loans playing only a minor role in education costs. It wasn't definitive, but now I view the "loans raise tuitions" crowd as holding an overly simplistic ideological position.

That demand was artificially created by the government disallowing the discharge of student loan debt through bankruptcy.

Ummmm...no, at least not according to the study I read. The study identified lots of reasons for demand. Mostly, it was the economic situation. When jobs get scarce, or people get fired, they often go back to school (or stay in school). That increases demand. And changes in population between areas also increases demand in particular regions. Demand also varies with percent of population at an age where they go to school. There was more to the study - but I read it a couple of years ago and never tried to memorize the details.

I'm trying to be generous in my response, and assume that you aren't simply trying to justify a philosophical position.

I think the US version of this discussion is usually about the extraordinary rise in SV, NYC and DC, even as the rest of the country shares low interest rates.

True, prices will also fall when interest rates rise, but it’s been a generation since that’s been practical knowledge.

It drives me crazy that people don’t see the very simple reason why tuition has risen so much: student loan debt is not dischargable through bankruptcy. Even if the student is run over with a bus the debt can be passed on to family members.

The lenders that give out these loans therefore have essentially no risk and are highly incentivized to give out loans to any and every person that wants one, regardless of their creditworthiness or future earning potential. Universities have responded to this glut of money and demand by raising prices.

The solution is to allow student loans to be discharged through bankruptcy. Banks will respond by properly evaluating the risk of each loan instead of giving them out like candy. This will result in less students going to college, but that’s a fair price to pay to correct this massive distortion in the market.

I would expect that such rising demand would result in more universities being built, and big expansions of existing ones.

This will happen eventually, but it takes a massive amount of resources to build a university from scratch, and existing universities risk diluting their brand if they take on too many students.

>Even if the student is run over with a bus the debt can be passed on to family members.

No, debt is never inherited. The cases you are thinking of is where the family members are cosigners on the loan. Nobody's child/sibling/parent/grandparent is ever responsible for a loan they didn't sign.

Student loan debt not being dischargable through bankruptcy is relatively recent; the increase in tuition has been going on for a lot longer than that. Even if the step you advocate is taken, US federal student loan guarantees will continue to have a large effect on tuition rates.

The relationship between student loans and tuition prices has always been the other way around - schools are more expensive so people take out larger loans. Government subsidies for student loans are comically low compared to actual tuition these days and have barely been keeping up - private student loans have always been available and the limit has always been based on creditworthiness of borrowers as opposed to government policy.

The idea that student loans leads to higher tuition prices has always been a politically motivated talking point from the right as opposed to something based in reality. Going to college or often going to as good a school as you can get into and afford is considered more important than ever before and disposable income and wealth among the upper middle class in the US have been going up significantly, not to mention among the global elites who see US colleges as status goods. On the supply side, prestigious institutions are hardly expanding their capacity for fear of losing prestige and school administrations are becoming increasingly market-savvy and less willing to charge less than below-market prices for otherwise wealthy students and their parents.

Its just that that's not how markets work. Prices go down in a competitive market ,and they go down over time. Cases where it doesn't go this way are usually monopolistic/rentist positions.

I just agreed to buy a house. It's very cheap. It's very small and strange, so thankfully banks wouldn't give a mortgage on it.

It was built around 1800, most likely when several people nearby got together and gathered a lot of stones to erect walls, and peat from a nearby bog and oat straw (which was grown locally) to make a roof. Over the subsequent hundred years it had a couple rooms added until it reached its current form.

The original owner almost certainly had no mortgage. How did they do it? Why can't I just gather materials and build my own house? Is it because of the inclosure acts? I'm not sure. It's also possible the house was owned by a wealthy local and used as housing for farm labour.

I suspect a lot of people _need_ mortgages purely because mortgages exist, so you're going to be competing against others who have them. It's slightly reminiscent of the two income trap. When a household wanted a home in the 1950's, they usually were competing with other single-income households. Once two-income households became normal, it was much more difficult for single-income households to compete.

Though this all still seems to relate to there being fewer houses than people would like to own.

Why can't I just gather materials and build my own house?

In the US, you certainly can, as long as you use approved materials and get the necessary permits and inspections.

If you want to fell trees and gather rocks to build your home, you can also do that, but it becomes much harder to get it registered as a homestead. In either case (assuming you are living outside city limits), you will probably need an approved septic plan.

You can build something that doesn't meet the local building codes, but it may be difficult or impossible to sell it later.

> Why can't I just gather materials and build my own house?

Indeed. This is why discussion of "supply" misses the point.

- Many people would quite happily build their own house in the middle of Central Park. But they cannot, because government intervention prevents them.

- Many homeless people would happily sleep in unused climate-controlled office buildings at night, but cannot, because government intervention prevents them.

- Many people would happily live outside of cities, but can't for financial reasons (effectively, the government coerces them via property law, into moving into cities to do work).

Supply is not the issue. There's plenty of supply already existing or easily created. The issue is that people are violently prevented from using it.

Are you suggesting that anyone who wants to should be permitted to build a house in Central Park? And that the "government" is unreasonable for preventing them from doing so?

No, I'm saying that the problem isn't "supply", but that access to existing supply is violently (and unevenly) restricted.

I'm interested in why you put government in quote marks. Do the cops who prevent people engaging in construction in Central Park not work for the government?

Indeed. The descendants of people who occupied central park ca. 1600 might have thoughts on that.

Central Park didn't exist until 1857.

The land which became central park did.

Who are you suggesting lived there in 1600?

The Wappinger confederacy most likely.

No, but I do think it's worth exploring the idea of a commons once more. I suspect a not tiny percentage of the population might be better off with a low-overhead lifestyle that we've made extremely difficult with our model of land ownership.

I respect property rights, which is why the more I learn the more our current system of selling the right to occupy land that was arbitrarily taken (from Irish and English farmers, from native Americans, or hell, even from Mexico) to be scaffolding designed to hide the fact the land was basically just stolen. Nevermind more recent outrages, like redlining.

I think to some extent we've made it impossible to live truly cheaply because those making laws can't fathom someone going wxthout modern services. I'd prefer NOT to have a paved road to my door, but because of the assumption I need that the costs of road building are a reason not to permit building. I'm ok with off grid power, composting toilet, and rainwater collection too, but it's assumed I want a sterile wasteland (a lawn) in front of my home and will need to water it.

Not everyone is mortgaged - quite a lot of the price rises are driven by foreign capital flight. A few places have figured this out and decided to tax it: https://www.bloomberg.com/news/articles/2018-02-20/british-c...

I've noticed this annecdotally when trying to buy a home on separate occasions in the New York and LA metro areas. I'm not sure it's foreign capital, but the majority of winning bids were all cash offers above the asking price.

I'd love to see a retrospective analysis on Vancouver's protective measures to see if they did actually help, or if buyers found loopholes, or it wasn't Chinese buyers to begin with.

I wish I could find the link now, but someone did a study on Vancouver and found that the tax had no effect on housing prices. The foreign buyers simply added it as another cost of parking their money outside of their country (usually China) and the math still worked in their favor.

It brought in some extra money to Vancouver though.

Of course it’s impossible to say with complete certainty, but... Vancouver’s housing market has stalled since the foreign buyer tax and vacancy taxes started to bite. Inventories are high and stubbornly stuck there rather than falling as they do toward the end of the year. Prices on high end homes are down a great deal - 20-30% for homes priced higher than $3M.

I would say that at this early stage it looks like the new taxes are working precisely as intended.

I think the confounding factor is that the tax would move the market whether or not foreign buyers are an issue. The price drops are also mostly at the top end of the market, which benefits wealthy buyers.

The drops are starting to happen lower down as well. The market stall is across the board.

Seattle's housing market has stalled too, with no tax introduced.

Not an "analysis", but here's the last (?) HN discussion on Vancouver's housing market https://news.ycombinator.com/item?id=14608918

I mean, yeah, some people don't borrow money to buy a home, but the vast majority (87%) do. A few years ago it was as high as 93% of homes were purchased with a mortgage.

https://smartasset.com/mortgage/what-is-the-typical-down-pay...

> ...want you to spend every penny you can. Everyone benefits from higher prices except the buyer. Even if you're immune to it, there is enough pressure that the market as a whole tends toward the highest prices people can afford.

This is definitely an American cultural phenomenon. Taking on massive debt is no trivial matter, and I can't imagine people buckling to peer pressure on something that will affect them so significantly.

It's dumb, financially unsound, and irresponsible. I know for a fact that South Asian/Indian heritage will (generally) never allow themselves to financially shafted like this. (The Indian people I know are usually very shrewd, extremely careful, deliberative, and reflective when it comes to major decisions like this.)

What this sort of poor decision making and buckling to external pressure amounts to is a lack of diligence, and a serious failure to look out for your own self-interest.

Why and how this lack of self-care has become a part of American culture is puzzling/baffling to me, and is probably a good topic for sociological or anthropological study and research.

Perhaps the overflowing abundance of wealth in United States (and other similarly wealthy countries) has made people less careful and more reckless with their money? I'm reminded of an article that appeared on The Atlantic which talked about how many people love paycheck to paycheck (and have very little saved up, even for emergency expenses): https://www.theatlantic.com/magazine/archive/2016/05/my-secr...

But as counter-examples, Germany and Japan are first-world countries where people have a habit of saving quite a lot. So this culture of poor financial decision-making (and generally poor self-care) is seeming more and more like a uniquely American thing.

So there is both a theoretical and an empirical relationship between real estate prices and interest rates but they have nothing to do with mortgages per se - you will find that this roughly holds true even in countries where mortgages aren't available.

The reason is that even in a world without mortgages, real estate tends to yield either payments (as an investment) or benefits (as the owner) that are roughly fixed and not entirely based on interest rates. If you consider the value of real estate to roughly equal the sum of discounted cashflows, this means the lower the interest, the higher the value.

Note that in theory, only land prices move this way, not the value of improvements, since the value of improvements is strongly tied to the cost. So if you consider the value of housing theoretically as a sum of land and improvements, only the land portion is subject to interest rates. So some have observed here that empirically the connection between real estate prices and interest rates has been weak - this will be the case in real estate markets dominated by the cost of improvements (most US markets until fairly recently I believe).

This is really evident in Canada right now with the mortgage “stress test”.

Basically, new regulations were created that require home buyers to qualify at prime + 2%, even though mortgage rates might be prime + 0.5%.

This was done because the govt was concerned about how much risk the banks were taking on.

Since it was enacted (earlier this year I think), the brakes were slammed on housing prices and now major markets are starting to see price drops. Of course the stress test wasn’t the only factor.

That seems like an easy stress test? I think UK lenders test 3% + the rate at which your mortgage reverts to at the end of the fixed period (we have relatively short fixed period products: 2-5 years), which would typically total around 7-9%.

Even if the majority of people choose the max they can afford, it doesn't follow that individuals can't freely choose cheaper houses for themselves.

Individual action doesn't matter. If you're only willing to spend 30% of your take home pay on rent, whereas your sociodemographic twin is willing to pay 50%, they'll outbid you.

Incidentally I currently spend 47% of my take-home on rent in London. At 32, buying a property is still out of my reach.

There are statistics on this in this related BBC article https://www.bbc.co.uk/news/business-42179119

I don’t think they’ll outbid you, they’ll buy a more expensive house.

And you think you'll be able to find a cheaper house? No, sorry: sellers will raise their asking price to match (or exceed) the market average. So, your choice really is between paying the same price as everybody else or not buy a house at all.

Every house does not cost the same amount. Yes, the average price might go up, but in my experience people will buy the biggest house they can afford instead of over bidding on a smaller house (in most markets).

They will when supply is constrained.

I think this is a minority of real estate markets (mainly SF and Vancouver). Even in NY there's enough of a spread that someone making 250k a year will have the option of buying a house under their max buying potential.

> They will when supply is constrained.

The point of the article is supposed to be that the issue isn't supply constraints. If interest rates only raise prices significantly when supply can't respond to higher demand, how is the problem interest rates rather than supply constraints?

>> Even if the majority of people choose the max they can afford, it doesn't follow that individuals can't freely choose cheaper houses for themselves.

The entire market is affected by this. You might spend less on a house, but the price of that house has already been influenced by the overall market. Homes in that price range are still at the maximum for people in some income range.

Correct. You will get less house for your money than you would if houses were not in high demand. Same as the price of everything else works. And if other people want to spend more than you on houses why shouldn't they?

Nobody is saying they shouldn’t, I have done exactly this, buying a house by taking the maximum mortgage I could afford to get the nices house I could get. We are just discussing the mechanism and forces at play and the role of interest rates.

Nobody said they shouldn't, we are discussing how interest rates effect the housing market as a whole.

I question it because this is how our worked for me. Maybe other people want something they can barely afford most of the time?

1. I go to banker for mortgage. 2. Banker asks how much I would like to spend and gets financials. 3. Approved 4. I go to real estate agent and say this is what I was approved for.

Never was there any pushback. I was far below my max limit.

Most people seem to do #4 first; which includes a "how much do you want to spend" but then is easily passed to "how much can you afford" then to 1,2,3.

The thing to think about is convexity. If everyone is maxing out their budget when rates are 2%, it causes a huge problem for their personal budget when rates go up to 4%.

If the rate was originally 10% like a few decades ago, each rate increment would matter a lot less.

Yes, we could be in for a lot of pain if inflation and interest rates rise over the coming years.

"Yes, we could be in for a lot of pain if inflation and interest rates rise over the coming years."

This is true, but I think unlikely ...

All macro trends - especially demographics and birthrates - point to large deflationary headwinds. The little bit of inflation that we experience currently is the result of massive manipulations like quantitative easing and related policies. Just look at the price of oil ... even the peak 2018 price is quite low when compared against the last ten years.[1]

Nobody can know how this will pan out, but I think a reasonable guess is that as QE is allowed to unwind we experience recessionary forces that we are no longer willing to accept or able to withstand - given the increased fragility and interconnectedness of our economies. And so we will see QE3 and QE4 and so on, with related ZIRP[2], until we finally see a deflationary collapse.

That could play out over decades. I don't know how you could shrewdly prepare for such a sequence of events, since the correct way to prepare for deflation is to have liquid, cash assets and those assets would be almost completely idle during the ZIRP period (like the one we are living in).

I suspect the only way we would see real inflation is if political actors made political decisions to massively overshoot the QE (and related) policies. Even then, we would not see high interest rates unless some later actor decided to "correct" that inflation.

[1] https://www.macrotrends.net/1369/crude-oil-price-history-cha...

[2] https://en.wikipedia.org/wiki/Zero_interest-rate_policy

> the correct way to prepare for deflation is to have liquid, cash assets

I agree that we're more likely to struggle with deflation and stagnation, and holding cash is the textbook response.

But in the last 10 years of ZIRP, cash underperformed every major asset class -- stocks, bonds, real estate, fine art, private businesses, precious metals, cryptocurrencies, even rare books [1].

Cash was the worst place to be.

We can blame it on QE, but policymakers will do infinite QE before they'll allow asset prices to fall very far.

So I'm not sure the textbook response is valid in the world we actually inhabit.

[1] https://www.theguardian.com/books/2015/nov/10/index-reveals-...

"But in the last 10 years of ZIRP, cash underperformed every major asset class -- stocks, bonds, real estate, fine art, private businesses, precious metals, cryptocurrencies, even rare books"

Yes, that is my point - the correct response to deflation is a very painful experience (and has been, as you note).

Since the deflationary collapse can be delayed be QE3, QE4, QE5, etc., that pain could last a very long time.

I don't know how to properly prepare for / hedge against the scenario I outlined.

> Nobody can know how this will pan out, but I think a reasonable guess is that as QE is allowed to unwind we experience recessionary forces that we are no longer willing to accept or able to withstand - given the increased fragility and interconnectedness of our economies. And so we will see QE3 and QE4 and so on, with related ZIRP[2], until we finally see a deflationary collapse.

It seems like the flaw is in the assumption that QE be required to "unwind" at all.

When the fed creates/destroys money, there are at least two things it can do with it. One is to buy/sell treasury bills, the other is to lend more/less to banks (who use it to make loans to consumers).

We currently have two problems: 1) too many loans to consumers, 2) too many outstanding treasury bills. So why doesn't the Fed set a near-zero interest rate for treasury bills but a higher interest rate for banks? That keeps them from having to destroy the money entirely and cause deflation to get consumer debt back to a rational level, while at the same time removing treasury bills from the market and reducing the interest rate the taxpayer has to pay on the outstanding debt -- solving both problems at the same time.

The result would be for the Fed to hold trillions in treasury bills indefinitely, but so what? The "harm" is that it allows Congress to borrow money more cheaply. That seems like a benefit provided they don't abuse it to the point of causing too much inflation -- which certainly doesn't appear to be happening in practice. The debt numbers would continue to grow on paper, but if it's all just going to be held by the Fed using created money, and the amount of money being created isn't causing hyperinflation, are we not good?

I’ve noticed with doomsayers it’s always deflation or hyperinflation. It never occurs to them that the Fed can do something that’s in between the two, such as what they’ve been doing for almost forty years since Volcker stamped down inflation.

Central banks in practice can print as much or as little money as they want. In the third world, they often do. Well-functioning banks like those we have in the Western world can do better, such as the way Iceland was able to deal with their entire financial system collapsing in one day. But it’s always intrigued me the way people talk about QE as though there’s something artificial. Artificial is exchanging pictures of George Washinton for goods and services. Everything else is an implementation detail.

The problem of “high house prices” is just imprecise language for “high cost of housing” - whether the cost is interest or principal is not terribly consequential.

> The problem of “high house prices” is just imprecise language for “high cost of housing” - whether the cost is interest or principal is not terribly consequential.

It actually is, because it affects what can be done about it. If costs are high because interest rates are high, buyers can lower their costs by paying down principal or taking a shorter mortgage. It's frequently the case that, because most of the payment is taxes, insurance and interest, a 30 year mortgage is e.g. $1500/month whereas a 15 year mortgage is only $1700/month, and the difference between them shrinks as interest rates rise (and original principal amounts fall). Which means more people can afford to stop having a mortgage payment after 15 years rather than 30.

It should also result in less resistance to densification, because people are less worried about home values when they're lower to begin with.

> Home prices vary inversely with interest rates.

This is true if all else is equal. In theory, however, the Fed is supposed to raise interest rates when the economy is heating up, which implies buyers are being paid higher salaries, which implies their income (step 2 of your chain) is higher. In theory this could neutralize some or all of the effect of the interest rate increase.

Historically, it is more about construction costs and comparable rent prices.

http://www.econ.yale.edu/~shiller/data/Fig3-1.xls

Can you describe how you reached your conclusion from the data in the spreadsheet? I don't see any of the three series correlating particularly strongly with house prices. My own pet theory is that adding the Fed's QE purchases to the graph would show stronger correlation than the series that are present.

Population and construction costs are a loose correlation with housing prices, but I dont see any correlation with interest rates.

http://lenkiefer.com/2017/12/20/state-population-growth-and-...

Here is the graph showing QE vs housing prices.

https://fred.stlouisfed.org/graph/?g=mbAe

Thanks... I look at the QE vs. housing prices graph and see plausible correlation. My bias, supported by the graph: "With house prices dropping, the Fed steps in to bail mortgage lenders out, keeping prices at their elevated levels"

> You will "pay" the same for your house (total payments) regardless of interest rates.

There is a missing branch in your procedure... step 4b) Banker refuses loan because combination of interest rates and house prices are too high for person to afford with current income:

> In 1991, 67% of British 25- to 34-year-olds owned property; today only 37% do.

I suspect this varying cut-off threshold of a substantial portion of the population is largely responsible in the apparent non-simplistic relationship between the other variables.

I think that change is better explained by the higher deposits required under the present high asset price low interest rate regime. The UK base rate was around 12% in 1991 and it is 0.5% today. If you assume an equal mortgage payment you now need a deposit 4 or 5 times as large to get on the housing ladder.

The article states there is a weak relationship between house prices and interest rates (with examples).

You have the mechanism right but I think you draw the wrong conclusion.

Your max amount changes with interest rates. So if interest rates rise your max amount goes down for the same payment and house prices go down.

>> Home prices vary inversely with interest rates.

That's exactly what I said. inversely means opposite.

Well then this is just false: “Ultimately your payment is determined in step 3 and has nothing to do with interest rates or home prices.”

You can’t have it both ways.

Do you have any experience with real estate or bonds, or is this just your pet theory.

While this sounds great to people who love to hate on anything financial, it is entirely wrong. You're basically arguing that more risk (larger loan) is cheaper.

But of course, if you were right, you could point to good data in this. (Remember to properly adjust for credit quality which is probably proportional to housing price.)

> The only thing the interest rate determines is who gets the money - the seller or the bank.

It seems here like you've forgotten that even though your payment may not vary, what you get will (e.g. will it be further out, smaller, apartment not house, worse neighbourhood)...

Or, ultimately, at the bottom end, your 'maximum monthly payment' isn't enough to buy at all so you rent forever (London, for anyone who isn't in a well paying field).

Consider - you'll probably be working 8 hours a week. For various reasons we settle on roughly that. But some people get paid very well and others don't. That matters regardless of whether everyone works 8 hours a week because most people don't retire early even if they could.

> isn't enough to buy at all so you rent forever

And landlords are willing to get a mortgage that can be paid for by the rent (modulo speculation).

"you'll probably be working 8 hours a week" - what?

The last bit is an analogy.

The idea that your payment is fixed and so the only thing that varies is the proportion allocated to different external parties makes no sense, because you're not buying the same thing.

People don't look at a house and say "I want that" and buy it. They look within their maximum payment range. What exists within that range is hugely influenced by external factors.

The analogy with an 8h work week would be that everyone 'pays' 8 hours a day for their free time so every other factor is irrelevant. Of course it's not; the particular job you end up with for your 8 hours (influenced both by your personal skill but also the external market) has a massive impact on your QoL.

I don’t think the poster is forgetting anything, just pointing out that the amount of money going into the housing market and bidding up house prices is directly based on interest rates.

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