Hacker News Reader

Comment by joppy | Hacker News Reader

Whatever the case, what you end up with is an asset whose actual value is tied to the interest rate (interest goes down, people can afford larger loans with the same repayments, therefore houses are worth more). This is a highly leveraged situation: if you take out a $1m loan and then interest rates go up, you're still liable for the whole $1m even though your actual asset might only be worth $900k now. I think this is one of the big dangers of having an essential need like housing cost such a large multiple of income.

View on HN

Kinda. If I buy a 1M home at 2.5% interest, I have a $4,000 monthly payment. If rates go to 6%:

- Housing prices plummet to $600,000, assuming people are willing to spend the same per month.

- My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly.

- If I move out, and I rent out my home, it covers monthly payments approximately exactly.

The only time the owner is in danger is if:

1) They need to move.

2) They can't rent out the original property.

Rent works out since while the home is a liability, with 6% interest rates, the 2.5% loan is an asset.

As a footnote, what I expect is actually happening here is people are anticipating high inflation. If that happens, this isn't a bubble. Real housing prices might be fixed, at least looking out a few years.

Not sure about the US but fixed-rate term in Australia is about 5 years. Nobody would give you a 30 year fixed rate.

You'd eventually have to pay 6% on the $1M.

30 year fixed rate is actually the “normal”/common mortgage in the US.

I moved to the US from the UK, where mortgages look more like Australia’s, and I still find it amazing you can fix such a low rate for so long here.

The weird thing is that 5 year adjustable rates are higher then 30yr. fixed. That only makes sense if interest rates will go down over the next 5 years, which seems unlikely to me.

Fixed-rate mortgages are government-subsidized by a range of mechanisms (Fannie, Freddie, FHA, etc)

Adjustable-rate mortgages are not.

As a banker I am perfectly indifferent whether I make a fixed rate loan or a an adjustable rate loan to the borrower.

I look my cost of funds, tack on my spread and that is the price you pay.

If you look at it from the bank's perspective it makes more sense. I got a 5 year and paid it off early. The bank got about 8% of my home value. My friend has a 30 year and the bank will get ~110% of his home value.

This is for 30 year 5/1 ARMs the term is the same, but the rate is not locked

The Macs drove subsidising the moral hazard of fixed rate loans into the public conscious, a subsidy for home owners, political suicide to take away. Better (politically) to rob from a generation or two to pay for reckless low interest rates.

Fixed rate mortgages are subsidized by the US government, that's why. The mechanism of the subsidy is extremely complicated, but it is not a small effect.

Before the creation of the enormous state-owned insurance corporations and government programs to drive down those fixed rate mortgage costs, American mortgages were usually short-term, with giant balloon payments. Those short-term, balloon-payment mortgages went bust in huge numbers during the Great Depression, creating pressure on the government to "do something."

Say what you will about American housing policy, but those 15- and 30-year mortgage arrangements are very stable.

Ya, the US has fixed 30 year rates. Interest rates are higher going from a 15 year to a 30 year to price in some of the risk to the bank.

The difference every time I bought a house was about 1%

The difference between a 15- and 30-year mortgage is around one percentage point, or a 30% difference.

I have a 30 year fixed rate mortgage of 2.375%. In the US, 30 year fixed is common.

@moosedev

Ya, my dad in Canada keeps encouraging me to buy property given the mortgages. Has its downsides, but over all its brilliant.

Damn, I would assume houses must be much cheaper in Australia than in the US? Or only the very very rich can afford to buy their own home? (Or is it amortized over more than 5 years, you just have a balloon you need to refinance?)

In the US, where 30-year mortgages are standard, the LARGE majority of homeowners would not be able to afford payments on their home amortized over only 5 years.

I dont have information that can compare Apples to Apples as such, as in US vs AU values.

But I can say that prices are rising rapidly here in Australia.

The already expensive Sydney market rose on average ~$1200 a day over the last quarter!

Melbourne isn't far behind!

We too have low interest rates!

Whats not clear is how people are paying for the houses. Where is the money for deposits coming from, and how are they servicing such huge loans?

Dual incomes and parents assisting would account for a lot of it. But what happens if/when the parents need the money back and the DINKies decide to have children and either lose the dual income or get slugged with child care fees!

https://www.theguardian.com/business/grogonomics/2021/sep/16...

I don't know about Australia, but it sounds like the comment you responded is saying that mortgages there are something like a US 5/1 ARM, not that they are paid off in five years.

That is, the interest rate is guaranteed for five years and then it periodically adjusts.

Yes, this.

>Damn, I would assume houses must be much cheaper in Australia than in the US?

The median home price in Australia is about US$725k. So no.

I looked for some official statistics, and while I'm not sure if I'm in the right place, it paints a rather different picture from yours. The figure for housing costs implies a typical home value of more like 300K USD or 400K AUD.

Also, if this is accurate, Australia is more of a nation of homeowners than of renters.

https://www.abs.gov.au/statistics/people/housing/housing-occ...

"66% of Australian households owned their own home with or without a mortgage.

32% of households rented their home.

Average weekly housing costs were: $484 for owners with a mortgage; $53 for owners without a mortgage; and $366 for renters."

484 AUD/week = 1500 USD/month 366 AUD/week = 1150 USD/month

It also says housing costs for renters have increased 51% in 20 years (to 2018) which is an average of 2% annually.

"housing costs are defined as the sum of rent payments; rate payments (water and general); and mortgage or unsecured loan payments (if the initial purpose of the loan was primarily to buy, add, or alter the dwelling)"

Nice data but that it's from 2018 before the covid boom...

> The nation's median property price lifted by 1.5 per cent last month (to $666,514)

https://www.abc.net.au/news/2021-09-01/property-housing-core...

That's a >50% increase over ~3 years and from the article 20% over the last year.

'according to the latest CoreLogic data.'

This appears to be a data provider oriented towards entities with large real estate portfolios, and they specifically say on their website that their "hedonic" index is not meant for affordability calculations, for what that's worth.

It's difficult for me to tell which index is in the article, but the note about the missing data under the chart implies to me that the article is (inappropriately) using the hedonic index. I wonder how much difference it makes.

'this month's figures from CoreLogic did not include Perth or regional Western Australia "pending the resolution of a divergence from other housing market measures in WA" '

"Rather than relying solely on transacted sale prices to provide a measure of housing market conditions, the CoreLogic Daily Home Value Index is based on a ‘hedonic’ methodology which includes the attributes of properties that are transacting as part of the analysis."

https://www.corelogic.com.au/research/monthly-indices

"The fact that median or other percentile based series cannot be used to track changes in value of a market portfolio does not make them wrong: it is simply that they have different applications than hedonic indices. For example, median price series are useful in answering economic policy questions relating to housing affordability."

https://www.corelogic.com.au/research/types-of-indices

Interesting points RE the hedonic index, I'm not sure what the intended use case is but we can approach it from another angle if you would like.

A more up to date government source has the following;

> Weighted average (mean) of the eight capital cities Residential Property Price Index... rose 16.8% over the last twelve months.

We could go on forever trying to work out the exact numbers. The main thing I want to do is show non-australians how quickly our prices have risen and are rising!

https://www.abs.gov.au/statistics/economy/price-indexes-and-...

https://www.afr.com/property/residential/what-the-national-m....

AUD$955,927 national median and AUD$1.4m Sydney median.

These are home prices, which excludes apartments and units. Some of the other figures quoted aren't.

Australia's housing market, like I'm guessing many others, is quite heterogeneous.

Sydney and to a lesser extent Melbourne are both completely unaffordable (A$1m+) to new home owners on an average income unless you're prepared to live in a unit or commute 2 hours a day to the CBD. Brisbane, Adelaide and Perth on the other hand are significantly cheaper and one could still afford a nice family home.

Also worth noting is that the huge boom in prices only really started in the early 2000s. People who bought prior to that period make up a disproportionate number of owner occupiers.

There's a huge difference between the Sydney/Melbourne markets (nearly 50% of the population) vs the rest of the country

See https://www.google.com/amp/s/amp.abc.net.au/article/10042389...

I think the rate is fixed for 5 years and then readjusted for another 5 years. The terms of the loan is a lot longer

30 year mortgages are standard I Australia too. After your initial fixed interest period expires you will then pay the current floating rates or chose to refix for another period (of up to 5 years) at the current interest rates.

The rate is fixed for 5 years. The mortgage is normally 30 years.

(Australian housing markets in major cities are some of the most expensive in the world.)

> If I move out, and I rent out my home, it covers monthly payments approximately exactly.

That's not actually sustainable. You have repairs you're going to need to do, sometimes unexpectedly large ones. You have tenants that move out, and then marketing expenses and/or vacancies. If you're unlucky you have bad tenants that do damage or don't pay or need to be evicted after not paying.

It can work temporarily (unless you are unlucky), waiting for a better time to sell. But most people who need to move don't really want to be in the landlord business, and it is a business with financial risk and headaches.

I would also add that there's nothing worse than being a landlord of a single unit/property. Pretty much all of the functions that you'll need to fulfill as a landlord take the same amount of time for 2-3+ units as they do for 1, except your potential returns are lower. Setting up a system to collect rent, managing repair requests and vendors, a tenant marketing/screening plan, extended vacancies, etc. are all much more painful to do for a single unit than for a collection of units. I see a lot of people throw the "just rent it out" line without considering any of this.

"If I move out, and I rent out my home, it covers monthly payments approximately exactly."

You cannot borrow for rent, so rents follow income growth more closely. So in some expensive real estate markets, if no income growth, rent might not cover your mortgage repayments.

Although true, for sure, when considering cash flow -- it's a fairly big upside that at the end despite having tenants pay most of the principal you end up owning it. Extra risk, etc, but housing prices falling is exactly the risk you're going into with wide eyes open so it's just a gamble.

But at the end, there's a decent shot you have full ownership of a house worth even more than you paid, and even if it loses most of its value you still own a place you can live in perpetuity paying only maintenance and property taxes. The renters don't get that, so it does kind of seem fair if they do not, in fact, cover your mortgage for you.

This is very true. I have pretty expensive home that I rent out which is in a pretty affluent area. The rent is insanely low relative to the supposed value of the house (3% cap rate).

You make s great point as to the reason for this. Rental rates are completely detached from current interest rates.

Let's say mortgage repayment is $3000, and rent only covers $2500. Let's add another $500 in overhead. I'm paying $12k per year. $36k would break me financially, but $12k is a good investment, since at the same time, two things are happening:

1) I am one year closer to owning the home. Yay!

2) Inflation. Rents next year might be lower, but rents in 10 years will be higher.

<- My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly.

You are a lot worse-off. If you buy at 6%, and then rates go down to 2%, you can refinance and your home is valued at a higher rate. IF you buy at 0%, you bought the house at the peak, and cannot refinance the debt.

But you would have a lower payment because you bought at a lower rate, no?

You would have the same payment as someone at a higher rate because at higher rates, someone would would have purchased the same home at a lower price.

> what I expect is actually happening here is people are anticipating high inflation

That's why price to income is an interesting metric. High inflation without income rise just means people feel worse off and a correction will occur. Housing, along with many other things, are competing for people's wallet. Interestingly, covid is causing a labor shortage and income to rise at the low ends. I suspect stagnating in the "middle income" ranges.

Inflation implies wages rise at the same rate as the price level. Otherwise it's not inflation. Not every price hike is inflation.

I’ve not seen that definition of inflation. I think you’re thinking of some type of equilibrium/market efficiency theory, where to support higher prices there has to be income growth, which is false especially in the short term where prices can rapidly rise faster than income could realistically keep pace and consumer is just worse off.

It's the standard definition, where inflation is a change in the price level, and the nominal GDP is defined as the real GDP times the price level Y×P. Since GDP is a just a sum of income components, of which one is wages, an increase in the price level implies a proportional increase in wages.

At 5% or more interest more than half your money goes to the bank rather than the house. At 0% all your money goes to the house. You can call this inflation if you want but then you are ignoring that you are paying a million dollars for a less than million dollar house because of interest.

The fact that spending and price are decoupled make the inflation idea stupid.

All your money goes to the house seller, remember that.

>- My monthly payments are identical to had I bought at $600k at 6%. If I stay there, I'm not much worse off. It's harder to pay off the home quickly.

>- If I move out, and I rent out my home, it covers monthly payments approximately exactly.

In any situation where interest rates go to 6%, there will probably also be some upheaval that affects your earnings and ability to rent it out at the present rental rate. The risks are correlated.

It’s a lot easier to come up with a down payment on the cheaper house though.

> - My monthly payments are identical to had I bought at $600k at 6%

I'm not sure how it works in the US, but where I live, you have a fixed interest rate for a couple of years max, after that you pay the market rate.

So in your case, if you had a fixed interest rate for 3-5 years, after those years pass, you'd have also a massive increase in mortgage payment, plus your house severely depreciating.

That seems to be the case where I live as well, though I believe there is a way to lock in an interest rate for longer. (Not a homeowner)

If interest rates rise to 6% and you've got 2.5%, the advantage would last that long. However, I know interest is front-loaded to the first few amortization periods, so maybe it would be more significant.

The U.S. is unusual in that rates being fixed for the full 30 year term of the mortgage is normal. They do tend to wind up with somewhat higher interest rates as a result, however.

This is the case in the US because rates are the same for the length of the loan. This is decidedly NOT the case in the UK, where the entire market is composed of teaser-rate loans (2, 5, 10 year), which revert eventually and then need refinanced at the prevailing rate.

That's going to be a nasty wake-up call for a lot of people.

I have a ~million dollar fixed rate mortgage. If rates go up, I’ll be sad that the value of my house went down. On the other hand, I’ll be very happy to have a large fixed rate loan. Let’s call my mortgage rate X%, and let us assume that rates go to X+5. Then I can invest money to earn at (X+5)%, which means my loan is essentially a $50k/year annuity. My only wish would be that I could make the loan even bigger.

On the other hand, if the fed decides to allow inflation instead of raising rates, then the value of my loan will melt away and my home’s price will keep going up (that’s what has happened so far).

The problem is that in a scenario of rates going up, both houses and general stock investments will go down together. They rarely diverge.

If rates go up to X+5, then I ought to be able to find bonds that pay X+5, no?

No. 30 year mortgages and 10 year treasuries move in unison but they are not the same rate. You can see this on the first graph here:

https://www.thebalance.com/treasury-note-and-mortgage-rate-r...

Treasuries are some of the lowest-yielding bonds out there.

Yes and treasures are the only bonds that move in lockstep with 30 year mortgages. When people talk about the correlation between bond yields and mortgages those are exactly the ones they are referring to.

US Treasuries also are considered among the safest, least risky assets out there. This is true globally and has been for a very, very long time.

This is all succinctly explained in the link I posted above.

Lastly bond prices have an inverse relationship with interest rates, which means that as interest rates rise, bond prices go down. So no, when rates go up to x+5 you will never be able to find bonds that pay x+5.

> Lastly bond prices have an inverse relationship with interest rates, which means that as interest rates rise, bond prices go down. So no, when rates go up to x+5 you will never be able to find bonds that pay x+5.

Indeed, interest rates are inversely related to bond prices. And bond prices are inversely related to yields. Yields and rates are highly correlated. In fact, the way banks finance mortgages is by selling bonds. The market rate they can get on those bonds determines the rate they can offer to homeowners. So of course these rates move in tandem.

> So no, when rates go up to x+5 you will never be able to find bonds that pay x+5.

What? If the current rate is x, this means that this is the rate a bond being issued right now is paying. If the rate goes up to whatever, it means that bonds being issued right now are paying whatever.

No, there is an inverse relationship between between interest rates and bond prices. This is an axiom in the bond market. See:

https://www.investopedia.com/ask/answers/why-interest-rates-...

Yes, I know that. We are talking about rates.

Rates on bonds are meaningless without considering yield.

Rate and yield are the same thing. Whenever I’m paying a rate, somebody else is earning a yield. Whenever I’m earning a yield, someone else is paying a rate.

They are related but they are certainly not the same thing.

Yield is a normalised rate of interest, so that bonds of different characteristics can be compared. When people say a bond pays certain interest rate, they mean the normalised rate, i.e. the yield, otherwise they would make clear they're talking about the "nominal rate", which is different. Therefore in most contexts, rate and yield are the same thing.

Anyway, the thing is if the spot rate is x% you will certainly be able to find bonds in the market that pay x% interest (=yield), regardless of the fact that a bond's yield and price are negatively correlated (an irrelevant fact, for the purposes of this discussion).

Yes.

If you had bonds before they went up, your bonds will crash. If you buy them after interest rates are up, it means you were in cash before and uninvested.

Im not sure I see the point in finding higher yielding bonds. Also they will have higher risk, its not "free" to have higher rates.

I don't know why you think home prices will go down if interest rates go up. they might not. especially in cities where everyone wants to go and where offer is low.

One of the things I am wondering about is how I have found housing that is not affordable to a single working adult but once you have two incomes the price is perfectly reasonable.

My hypothesis is that if there is a shortage of housing, then dual income households will bid the price up and this causes the appearance of unaffordable housing when the underlying cause is that there is a shortage. This effect does not happen when there is a housing surplus.

Supply and demand would indicate that higher interest rates would reduce demand. However.. demand is not ONLY driven by average cost. For people to straight-up not want to buy homes anymore would mean they'd need to move, or switch to renting. Prices may fall but I don't think they'd fall in lockstep with interest rates.

The value of all yielding assets is tied to interest rates. The risk free rate is a bench mark for measuring any type of return, so any time you change that you’re going to influence the valuation of everything.

There’s also a very clear distinction between the idea of housing and home ownership. People need a place to live, they don’t need to have a property investment. You and I need healthcare, but neither of us need to own a hospital.

Home ownership is not an essential need. People aren't excluded from housing because of that risk. They can just rent from a landlord who's taking that risk themselves.

True. Renting has other risks though. The Landlord can increase the price dramatically at least as often as you renew your contract (usually a year in the US), or force you to move out because they sold the property, or really almost any reason. And because moving has such a high transaction cost, landlords can often get away with treating tenants pretty badly, because putting up with a bad landlord is often less bad than having to relocate your home.

It's almost as if playing in the rat race isn't easy or fair. Moving to a rural area or living on social welfare is usually also an option but you have to quit the rat-race to do that and miss out on all the wealth and social status.

If you move to a rural area you still have to buy or rent, the prices are just lower, and there are a lot less options to rent.

> if you take out a $1m loan and then interest rates go up, you're still liable for the whole $1m even though your actual asset might only be worth $900k now. I think this is one of the big dangers of having an essential need like housing cost such a large multiple of income.

You could always walk away. Better to be under water on a mortgage than own it outright. This is called a strategic default. Lenders know this which is why they require a substantial down payment (typically 20% in the US)

Most people wouldn't do it if they're slightly under water. But eventually many people would consider walking away and taking a hit on their credit score, which get totally wiped out after 7 years anyway.

This is only true in states with non-recourse loans. Many states have full recourse home loans that would require the homeowners declare bankruptcy to "walk away"

Yeah, and I don’t think bankruptcy disappears from your credit report after 7 years like other items. Does it?

Bankruptcy does eventually disappear I think, or if it doesn't there are legal requirements not to hold it against you after X years without a problem on your end. It's been a while since I've looked into it.

The irony, of course, is that the US Bankruptcy Code provides you can't declare bankruptcy again until 7 years have passed. So creditors theoretically have less risk during the period they generally refuse credit to the newly bankrupt. Of course none of that applies to business bankruptcy, where the old company is often dissolved but you're often looking to the same former principal(s) for personal guarantees of the new company's obligations.

There are a number of lenders who are willing to extend credit to those with a discharged bankruptcy (on terms far worse than someone with an 810 credit score, of course).

7 years (Chapter 13) or 10 years (Chapter 7).[1]

[1] https://www.lexingtonlaw.com/education/how-to-remove-bankrup...

Being underwater is only a problem if you want/need to sell. Choosing foreclosure is a bad move, not having a choice is different.

Not if you get a fixed rate.

When I checked out a 5/1 arm at around 2.25%, even the maximum interest rate was 7.5%, which is pretty good historically.

If you try to sell your asset, buyers will be stuck with a higher interest rate, which pushes up the effective price of your home (and the extr money doesn’t go to you.)

I think you misunderstood the parent comment.

Even with a fixed interest rate, you still owe the entirety of your borrowed amount on the $1m purchase to the lender, but your property value may drop if the interest rates go up because, assuming the market value is tied to the interest rate, new buyers won't be able or willing to borrow $1m to buy your place at a rate higher than what you borrowed your $1m at. For the same monthly payment as you have now, a new buyer may only be able to borrow enough to afford a $900k home.

Someone with the same income and monthly expense limit as you wouldn't be able to afford your home, assuming rates went up, which is why the value might drop - fewer buyers.

True. But that’s nonetheless likely to be transient over a reasonable time horizon for home ownership, e.g. 10 years.

It affects things like refinancing, pmi removal, and helocs as well when appraisals come in lower.

Agreed

Reply on news.ycombinator.com