It’s insane to me that you could buy a 10 year treasury around 1980 that paid 17%.
That’s more than double the long term stock market return, and it’s (basically) risk free.
That’s more than double the long term stock market return, and it’s (basically) risk free.
Dad was getting phone calls just begging him to refinance his 3.5% mortgage to current rates. "We have a low-low 18.5%!" Nope.
He would record every payment on the booklet you got with the mortgage that had the amortization schedule printed in it.
The problem is that most people don't understand these things and are stupid, and decide to buy a house and sign all the paperwork without reading it.
The problem is the amount it can help you and the amount it can hurt you are disproportionate; if the rates fall enough to significantly help you, you could likely have a similar reduction by refinancing a fixed rate mortgage. But, if rates go up, you can't refinance to get a better rate, and you may have trouble selling as you may have planned, because higher interest rates put downward pressure on prices.
For me, it seemed like the risk was not worth the reward; especially given I was borrowing in 2009, and rates had significantly more room to go up than to go down. In the 1980s 20+% interest rate climate, I may have chosen differently.
You do have to pay loan original fees again though which can be 1-2% of the balance of the loan so you have to compute when it actually pays off for you and whether it's worth it.
My lender had a program where you paid a nominal amount (originally $500, but later $1000) and they'll adjust your rate to their then current rate. If you do a full refi, my understanding is that's going to cost in the neighborhood of $3000, although many lenders will roll that into the loan, or otherwise hide it.
[1] https://www.nolo.com/legal-encyclopedia/when-are-prepayment-...
Reminds me of the time I bought a package at a pawn shop, but didn't want one of the items in it. They said that to get a discount, I'd have to buy the whole thing as is then pawn back the unwanted item. So far, so good, but then I had to give my ID and attest that I didn't steal that one item ... even though they knew it never came from me to begin with!
[1] The way you said it, thousands sound like the typical case and $500 is a special deal.
Just adjusting the rate in their systems certainly doesn't cost the lender nearly $500 or $1000, but it was still a win-win. They got some money to offset the lower rate, and got to keep servicing the loan, and I got to pay less interest, it's been a while, but I seem to recall my break even was about 3 years each time. I would certainly consider the availability and price of rate modification when considering lenders in the future.
See, this is what banks are explicitly NOT in the business of doing. They are in the business of borrowing short and lending long, with a rate spread to make money in the process.
I have had a number of mortgages in the last 10 years in the US (refinanced multiple times), and none of them had any prepayment penalties. I suspect if I looked for one that does I might find it and it might have a slightly lower rate. Maybe. That depends on whether the bank planned to keep it on the books or sell it on; it's easier to sell on standardized mortgages into an MBS than weird ones with bespoke terms.
See that makes sense with variable rates. However if you offer a 30-year fixed rate at 4% because you know that you can currently borrow short at 2.5%, what happens in 20 years time when no-one is willing to lend short to you for less than 6%?
1) The loan is still on your books. In that case, you are in the same situation as an individual who has invested money in a 4% bond and can't withdraw it from there while at the same time paying 6% on a car (or house, or whatever) loan. It's annoying, for sure, but whether it's a serious problem depends on your net assets (which you might draw down to make up the difference) and your net income at that point (which will depend on whether you are still managing to make loans at higher than 6%). Also, 20 * 1.5 - 10 * 2 = 10, so I think you you still come out positive in this scenario, subject to some _really_ simplifying assumptions like the rates being 2.5 and 4 for 2 years and then jumping to 6 and 4, and ignoring the fact that money now is more valuable than money later, etc. But yes, if you keep the loan on your books you do run the risk that rates will go up and the money will not be optimally invested; you presumably try to model that risk and price it into your rates.
2) You sold the loan on to investors in the form of bonds. In that case you really don't care that much, as the loan originator. The investors who bought a 3.25% (or whatever; some loan management fees come off the top) bond now have the problem of having a bond that is paying likely below-inflation rates, and can't be sold, except at a loss, because of that. If the question is why investors would buy such a bond now, it's because they need something to invest in and pickings are pretty slim if they want a risk profile better than stocks (and we can argue whether morgage-backed securities give you that) and they are betting rates won't go up that much.
Now you could ask why people generally buy fixed-yield bonds at all, which is really the same question. My guess would be that partly this is a bet that rates won't rise (partly driven by central banks' commitment to macro stability and therefore not having too-large changes in interest rates). And maybe partly an issue of what time horizon the bond purchasers are operating on...
1) Recession 2) Negative interest rates.
in theory one could make a bet that a recession will occur in X months forcing a rate cut/stock decline and use leverage on fixed rate investments to make an above average return.
If anything, it's a huge anomaly that this facility isn't routinely available to retail customers, and an indication of lack of competition within the banking sector in many countries.
You can go longer but the bank will factor that with a higher fixed rate to offset variation.
I'm honestly surprised that became the standard, it seems like a lot of risks for the banks for what they're getting. I think it has something to do with Fannie Mae and Freddie Mac preferring to buy some mortgages and absorb the risk?
And of course the 2008 'financial crisis' didn't really result in 'stable inflation' in the US within the last 40 years.
On a per consumer level a variable rate is much higher risk, even in countries with highly variable inflation rates some fixed form of incomes will not inflate uniformly with the economy and a variable rate would increase the rate of defaults. On the other hand the loan terms and risks are determined once at loan origination where it's quite feasible for a financial institution to hedge out any long term inflationary risk.
You still pay something as the loan has a management fee on top of the interest, so you can end up paying approx 0.6% in interest in the variable loan that can change every 5 years. The mortage loan can only cover up to 80% of the value of the house, with rest being 5% cash and 15% a more normal, higher-interest bank loan.
How much you can loan is based on a multiplier of your household income typically.
The 30-year fixed loan is 2% effective interest. And you can also not pay any interest for up to 10 years.
The establishment have not made the same mistake again. When you have people in perpetual debt you have them under perpetual control.
Credit can be created at will, but if you accidentally let financial independence break out, it's not easy to put back in the bottle. You have to wait for the next generation.
When prices looked like they were going to drop, the government stepped in with "help to buy".
The free market rhetoric is just that. It's a complete and utter lie.
Sure, the mortgage that would be paid off in 5 years now has another 20 years of payments left, but hey lower monthly payments!
I had a mortgage originated in 2009, and then rate adjusted down several times to something in the 3.x range -- and would get calls and mailers promising "historically low" rates of 4.x; which I always found very amusing.
Dad was very financially literate and would hang up on them after a short "no thank you". If for no other reason than they interrupted the family dinner.
That is, second attempt -- his first attempt, when oil prices were still high, didn't work.
You could buy a 10-year bond paying 8% in 1970. That's a high yield by 21st-century standards but it performed quite poorly [1]: when you got your principal back ten years later it was worth less than half as much due to inflation (and not even by reinvesting the interests received would you break even).
[1] not worse than stocks, though
You're comparing nominal and real numbers here. The nominal rate was more than double the long term _real_ stock market return, but the corresponding real rate was 4.5%, as the inflation rate was 13.5% in 1980. That's a more accurate and much less eye-popping number.
You also risk that the bond is not honoured - that's a really low risk for the US Government, but it's also not 'risk free.'