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Comment by throwdecro | Hacker News Reader

> Homebuyers will make purchasing decision based on their monthly mortgage payments, instead of the home price.

Which is crazy, right? People max out their "borrowing power" at low interest rates and take on huge loans, without considering that the declining interest rates that fueled past appreciation don't have much room left to move down, and that they'll be underwater on that huge loan if interest rates go up* and the value of the property declines.

*EDIT: To be clear, I mean interest rates on new loans being higher than they were before, not that the loan is variable-rate.

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> Which is crazy, right?

No, because this is not accurate:

> Homebuyers will make purchasing decision based on their monthly mortgage payments, instead of the home price.

Homebuyers make their purchasing decisions based on the options available to them. They are not paying $x because they can afford $x+1, they are paying $x because that is how much they are willing to spend on that specific house in that specific location. The latter portion of that statement is important because implicit in it is the competitive nature of humans, and so it manifests as people competing to purchase land and being willing to pay as much as they can afford in exchange for the utility from that specific house in that specific location.

That utility can be in the form of access to income opportunities to lower future volatility of income, access to other people of similar or higher income so your kids can go to school with their kids, access to airports, downtowns, outdoor recreation, etc.

If you are projecting increased demand during your entire lifetime for the piece of land you are purchasing, then it makes sense to pay as much as you can afford, as it will only get more expensive. If you are projecting a receding economy and/or decreased demand for the land you are buying, then it does not make sense to pay as much as you can afford, but rather scale it to some measure of what utility you will get out of it.

> If you are projecting a receding economy and/or decreased demand for the land you are buying, then it does not make sense to pay as much as you can afford...

I think this is the above commenter's concern; homebuyers are not adequately pricing the risk of rising interest rates. If interest rates go up, demand falls and you're left in a highly leveraged position that amplifies your losses. Monthly mortgage payments don't make the leverage apparent. Sticker price does.

But if you go one move deeper central bankers will factor the high leverage in and therefore won’t increase rates.

In order for central banks to mitigate future recessions, they need be able to make rates go down too, not just not increase them. And when rates increasingly approach zero, there won’t be much they can do, except buy the assets - which they have done and are not supposed to.

Bingo.

> If interest rates go up, demand falls and you're left in a highly leveraged position that amplifies your losses.

There is a reason why debt is called “leverage” - it leveraged investment returns up when your the exit works out.

But it also leverages return losses down when the exit doesn’t work out.

As long as most people in the U.S. buy houses with 30-year fixed mortgages, the total cost of a house will be 30 * 12 * monthly mortgage payment. When interest rates are low but home prices are high, they don't pay any more over the life of the loan. (Someone who buys when rates are high but prices are low does have the option to refinance, though, which is not available to someone who buys when prices are high.) The change in interest rates effectively shifts which portion of the buyer's income goes to the lender vs. the seller.

This is similar to how increases in local incomes are actually captured by landlords rather than workers. If housing is scarce and people need it to live, owners of that housing have the bargaining power to raise prices to capture available income.

It's true that a homeowner who pays a higher principal and a lower rate isn't really at a disadvantage if they stay in the home for 30 years (with a 30 year loan). But if rates go up a bit as soon as they need to sell they're going to find far fewer buyers.

And their neighbors will have already found out they had to sell for lower amounts, resulting in some others walking away instead of bringing money to the table at a sale. At thus begins the downward cycle.

The point is that interest rates don't affect the cost of housing which is determined by monthly payment * 360 months, they affect the resale value of housing. If interest rates go up the resale value of your house goes down.

If people bet on the resale value of housing to go up they also necessarily bet on lower interest rates.

Do you really have 30 year fixed rates? They must be ridiculous?

That’s the standard in the US. Current rates are about 2.75%, although they went below 2.5% for a bit earlier this year.

Those rates are for 20% down, good credit primary residences purchases. Rates for investment or vacation properties are generally about 1-2 percentage points higher.

Mortgage rates in the US are indirectly and directly subsidized by the government across a huge spectrum of programs- See FHA loans, VA loans, etc. However one of the biggest contributors to low 30 year prices are the government backed corporations like Fannie Mae and Freddie Mac that purchase mortgage debt and repackage it into mortgage backed securities. Way too much the go into here, but a lot of the 2008 financial crisis has its roots in the policies that created Fannie Mae and Freddy Mac. Regardless, they have proven a fairly effective way to keep mortgage rates low.

Interesting. Higher than here currently of course - I was recently quoted 1.16% for a five year fix - but I've never heard of being able to lock in something pretty reasonable for the full term/30y like that.

But are lower shorter term fixes also available? Presumably the 30y fix is a pretty stable rate, and just acts as an upper bound? So why not go with anything available that's lower, with that as a worst case fallback that's unlikely to be materially different after x years?

Yes, you can get a shorter term loan and have a lower interest rate- 15 years is also reasonably common, and fixed rate products exist at 20 and 10 years respectively. Adjustable rate and 5/1 or 7/1 products exist as well, but they aren’t as popular or encouraged by regulators, as they played a role in the 2008 financial crisis.

As to why go for a 30 year loan instead of a lower interest rate 15 year the answer is basically cash flow and opportunity cost. A 15 year loan may result in paying less interest, but the monthly interest + principal payments are more. Your average borrower will qualify for a larger 30 year loan because the analysis is based on their ability to afford the monthly payments based on their current income.

Even people who can easily afford a 15 year loan will choose a 30 year because the 0.5-1% interest rate is lower than the expected returns of something like stocks, so it makes sense to stay leveraged. There are also tax benefits to paying interest (but not principal) on loans, but these are way less important since the trump tax reforms.

And I just reread your question, and I think you are asking about 5/1 loans. The reason there is that a) interest rates so fluctuate, a lot- they were above 9% in 1991. With a 30 year, you can choose when you refinance (there is no penalty to paying off a home loan early in the US) whereas with a 5/1 you might find yourself getting forced into a higher interest rate- potentially much higher to the point it’s unaffordable. 5/1s also actually have a higher interest rate than 15 years currently, as they aren’t considered “conforming” to various US government programs.

> Even people who can easily afford a 15 year loan will choose a 30 year because the 0.5-1% interest rate is lower than the expected returns of something like stocks, so it makes sense to stay leveraged. There are also tax benefits to paying interest (but not principal) on loans, but these are way less important since the trump tax reforms.

On the other hand, it probably reduces risk to take the 15 year loan if you can afford the payments, in order to more aggressively build home equity and shield yourself from a sudden shock/downturn. If rates shoot up after, say, 5 years (and home values drop 20%), someone who's made 5 years of payments on a 30 year loan will be way underwater, whereas someone who's made 5 years of payments on a 15 year loan still has positive equity.

Homes are massive, illiquid assets with high transaction costs and (unless you have many of them) are poorly diversified. I'd even argue it makes more sense to look at a primary home as a forced savings plan rather than as an investment.

I disagree. It’s too big a chunk of people’s net worth to not analyze like a financial investment, if only to make one stop and think about them opportunity cost of buying at various price points and how much you are really spending to consume living in a nicer house (because there is definitely a consumption angle.)

A primary residence even makes a good component of diversified portfolio so long as it is not the sole or dominant aspect of that portfolio.

I understand your point about it being a "forced savings plan", but with 5-10x leverage on most loans even a housing market that appreciates at inflation can provide significant returns (or losses) in the long run.

Don’t discount how rare 20% price drops in housing are historically - a nationwide 20% price decline has only happened once since 1951 (where I could find statistics start) and even then would only have applied for purchases in a 1 year window. House prices are historically high across almost any metric you choose right now, so we could see another incident of that, but it’s also possible we could see real house prices depreciate with inflation while holding nominal value.

I didn't mean shorter term loan, just shorter fix. I think the answer is it just works surprisingly differently here (UK) vs. there (US).

Here a normal thing to do is something like 30 year loan on a 1/2/3/5 year fixed rate, after which it would be some relatively horrendous variable rate [^] - but you don't pay that, you just switch to a new fixed rate at the same or other provider (technically remortgaging).

So you're leveraged for the full 30 (or whatever) year term regardless, but you make some decision about how 'good' you think the rates are at the moment and what direction they're moving in (and pretend your adversary isn't a massive bank with a lot more information and smart people behind it) and fix for accordingly many years (more costing a slightly worse rate of course).

[^] - you could also just choose a variable rate to begin with, but that's not really relevant here, I just mean I think typically the rate you'd drop to after the end of the fixed rate would be worse than that, as in you're going to pay more spread over whatever it's tracking.

Europe has them. They're not ridiculous. 1.5% fixed for 25 years is somewhat common.

Where?!

According to the ECB, https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2322~0ed0879d... :

"FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain"

UK is also ARM but not included as not in euro zone.

Note that at least in the NL market which is the only one I know personally, lots of people do get shorter term fixes compared to the US where almost every mortgage is fixed for its lifetime.

This is a way bigger problem in Canada, where fixed term mortgages are unavailable (and where price to income ratio is even more absurd than in the US).

If anyone in the US thinks "housing costs can't keep rising, the market will correct itself", then just look at Canada. The average sale price of a home in the US is roughly $375k. In Canada, it is about $700k, and property values continue to rise.

I guarantee that housing in Toronto will continue to climb at 10%-15 % per year. Housing is the only thing keeping the Canadian economy afloat. The BoC has no choice anymore, they will pay your mortgage if necessary. I dare them to raise rates to just 5%, there will be a collapse that will leave half the country in the streets. If you can afford to buy, buy with both hands. You will double your money in the next 5 years, a house in Toronto will be over 5 million in the next decade.

Well, it better keep going for another five years after that, and then another five years after that, and so on, because anyone buying a $5 million 4-bed-2-bath house for their family is only more dependent on that trend continuing than the one who paid $2 million. The price tag is only justified when there's no end in sight to the appreciation. Nobody would pay $5 million for that house if its value stops rising, let alone starts dropping.

The government can't guarantee real estate, because any 99.9% risk-free investment with 10% annual growth can be levered into a 99% risk-free investment with 100% annual growth, and that's going to absorb all available capital like a black hole. The more the government acts to reduce risk without offsetting that by reducing returns or increasing the cost of debt, the bigger that black hole will grow.

At some point, it might be worth biting the bullet and incentivizing investments into sectors of the Canadian economy that aren't housing. If workers can see housing appreciating by multiples of the median salary, and entrepreneurs clue in to the fact that they'd earn more as a real estate agent than by building a tech company, "the Canadian economy depends on housing" becomes a self-fulfilling property. A few more doublings and then there's no point bothering to do anything else like growing food and assembling cars. Then you end up with a Zimbabwe situation where, yes, your house is worth a trillion dollars and rising, but it's not... good.

But maybe if we keep pouring enough gasoline on it, we'll be able to put out this fire?

"The price tag is only justified when there's no end in sight to the appreciation." Isn't that pretty much the definition of an asset bubble. Prices have decoupled from underlying asset utility (eg. rent) and it has become speculation on future price growth. As no return to justify the price all of this seems to hang on optimism/pessimism of future buyers. And availability of easy credit of course.

I know you weren't saying this at all but that first sentence is dangerously close to "we've reached a permanently high plateau".

https://en.wikipedia.org/wiki/Irving_Fisher

> without considering that the declining interest rates that fueled past appreciation don't have much room left to move down

Negative is inevitable, imo

If the value of your home rises, you've effectively taken out a hugely profitable leveraged loan, which is historically pretty common. Which is far from guaranteed of course, but broadly speaking it was an amazingly lucrative move for many many people.

Why would I lend you a million dollars only to be paid back over 30 years and have less than I started with at the end of the 30 years? I'd be better off doing nothing with the money.

You wouldn't, but the government might - to keep the economy propped up. I think this is what parent meant, anyway.

Not sure that's a healthy point for the government or the economy to get to, but with politics the way they are these days it doesn't sound that farfetched of an outcome...

If things get to that point, the government might as well just buy all the housing.

It has already been done.

https://www.investopedia.com/articles/personal-finance/05141...

Because you don't want to keep 1 million dollars under your mattress.

Maybe I do if my other options are this bad.

Although if the reason the government is doing negative interest rates is to prop up home prices forever and ever, I guess I better put my money into housing.

Your home is not special. If the value of your home rises, the value of other homes also rises, which means for most homeowners an increase in the value of their home can't be turned into a profit.

If Alice buys a home for $100k and it appreciates $1M over ten years, and Bob rents for ten years for $100k, total. Alice has $1M more than Bob does. That isn't nullified if Alice chooses to buy a $1M home next. She can also go buy another $100k home instead and pocket the $900k. Bob, obviously, cannot pocket anything.

> She can also go buy another $100k home instead and pocket the $900k

No, that's my point. A home that cost $100k when Alice bought hers, now costs $1M, therefore if Alice sells her home for $1M and buys another one for $1M, she makes a profit of $0.

Bob, with a net worth $1M lower than Alice, would probably disagree that she has not profited.

Only if you do fraudulent accounting. Mark-to-market is limited to assets held for trading, as far as I can tell, and for a good reason.

If you sell your home for $1M more than you bought it, it would be fraud if you didn't consider it a gain.

If you sell it and become homeless, yeah. Otherwise you'll be buying a $100k home for $1M, which cancels out all the profits that you made from the sale.

That's not how profits work. Or accounting in general. If you sell for +1M and then buy a different home for $1M, you've recorded a gain of $1M. It doesn't matter if you spend it on another house or don't. Your balance of cash may stay the same, but you've still profited. And the gain is taxable.

That's the accounting profit. Suppose you keep the house, your accounting profit would be zero. If instead you sell the house, and buy it back immediately for the same price, now you have an accounting profit. From this example, it's obvious that the accounting profit can be misleading. What matters is not the accounting profit but the economic profit (aka actual profit).

This assumes you continue to own a home, and own a home in the same market.

You can downsize, rent, or relocate to realize profit.

There is a reason why they must go negative...

Inflation is going up because of a mix of supply shocks and fiscal stimulus. Not necessarily a bad thing but it's out of the realm of monetary stimulus.

Low interest rates in Japan failed to drive inflation. Ask any Austrian economist and they would tell you that low interest rates are guaranteed lead to malinvestment, an artificial business boom and high inflation. You know, if it was that easy then central banks would have raised interest rates a long time ago. Probably shortly after 2008. Whatever is going on is way beyond what monetary policy can do.

At 0%, monetary policy simply stops. Game over for monetary policy. Central banks do not matter anymore.

>You know, if it was that easy then central banks would have raised interest rates a long time ago. Probably shortly after 2008.

The Fed attempted to raise rates in 2011 which lead to the so-called "Taper Tantrum" where stocks plunged. The Fed either got scared, or received a phonecall, and promptly held off on increasing rates.

This is my worry too. I just sold, with the intention of buying back into the market (in a different city). I'm terrified by the amount of people maxing out their abilities to handle the mortgage even at today's incredibly low interest rate. I'm making sure I can handle a quadrupling comfortably – but also those of us acting like that suffer (or will suffer, when there's a crash) the consequences of the reckless ones.

I don't like the feeling of a market where trying to be a rational actor barely helps.

I don’t know how it works in US but can’t you just opt for fixed interest rates ?

Yes, most people do, it's just that increases in rates have a tendency to cause decreases in homes values because a larger proportion of monthly payments will now have to go towards paying the interest.

Yeah, you can. A random example I found from Rocket Mortgage is a 3.25% fixed interest rate for a $200,000 house.

https://www.rocketmortgage.com/learn/30-year-fixed-mortgage-...

2.1% if you but ~$5k in points right now.

The standard mortgage in the US is a fixed rate 30 year mortgage. You can get lower rates for 10, 15, or 20 year mortgages. Also generally you pay an extra fee (PMI) monthly if you put less than 20% down. Adjustable rate loans and interest-only loans are still available but those are really not a good option unless you are not planning on staying in the home long.

There are some other options out there for veterans or first time buyers, but those are the normal options.

Yes, you can, but it doesn't address the problem mentioned above.

>> the declining interest rates that fueled past appreciation don't have much room left to move down, and that they'll be underwater on that huge loan if interest rates go up* and the value of the property declines.

The price you can charge for something is related to how much other people can pay for it. If houses are usually bought with loans (which they are), then the availability of loan funding is a major influence on the price of a house. When funding is plentiful -- another way to say this is that interest rates are low -- the price of a house will be high. When funding is hard to find -- or interest rates are high -- the price of a house must drop to compensate for that.

In practice, when interest rates went sky high in 1980 the price of home didn't actually drop very much. Instead, liquidity dried up. Nobody bought homes; nobody sold homes. The few people who had to sell their homes got screwed, but in general people rarely have to sell their homes unless they get transferred to a new office and don't have enough to buy a house there in cash (which is very attractive when interest rates are high; when borrowed money is expensive, houses get cheap to match what you can borrow, and if you happen to have money, you just don't borrow and take advantage of the cheap prices to pay cash).

It is common for people that can afford to pay the mortgage/house keep it even in a down market. IT makes housing crisis a lot longer to weather out because the vast amount of capital gets locked in an asset that does not yield its prices.

The bleeding ends up being slow, a decades wait to see any returns while maybe the stock market soars.

I am not very optimistic on homeowners in a downturn, UNLESS the government bails them out.

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