Mortgages are a manufactured product
bam.kalzumeus.com
bam.kalzumeus.com
1) Default risk - Obviously if I invest in pools of mortgages, and a lot of people stop paying their loans, I am exposed to risk. In many cases I'm insulated, because if someone defaults, I now own the home and can sell it to recoup my losses. But there's costs associated with foreclosing and in some cases, the value of the house goes down by enough that I can't recoup my money anyways (see 2008). We slice and dice mortgage pools to reflect this, so that the junk bonds are at the bottom and pay more and the AAA are at the top and don't lose anything until the lower tranches lose everything.
2) Interest rates rising - he discusses this in the article. If interest rates go up from 5 to 10% then any notes I held on a 5% loan are worth less.
3) Interest rates falling - this is called "pre-payment" risk and is what makes mortgages so interesting (and much harder to value than corporate bonds and most other loans). See point 2 for why rates rising hurts the owners of mortgage notes. You might think that rates falling would therefore help them, but it doesn't directly correlate. If rates fall enough, many people will refinance their loans. You have the right to pay off your mortgage at any time and another bank will be happy to step in and give you a new loan. So if rates fall from 4% to 2%, you can bet that most people will refinance. If I'm an investor holding a pool of 4% loans, then most of those loans will get paid off and now I'm stuck being in a market where I can only buy pools of 2% loans. Corporate bonds generally don't work this way. Auto loans technically do, but given the size and durations of the loans, it's usually not worth the hassle to refinance in the way it is for a house. This pre-payment risk makes the modeling of mortgage investment much more complicated, but also more interesting than many other financial securities.
Are mortgage rates and cap note returns in the US not tied to the federal interest rate?
Here, pretty much every note traded publicly will yield x% above RBA (reserve bank) interest rates, and most mortgages will be "variable rate" - ie they'll automatically adjust to be some function dependent on the RBA rate.
A typical value is 5 years.
When I first bought my house interest rates were over 7%, so getting discount on the interest in exchange of the risk of an adjustable rate mortgage made some sense.
Only briefly; the 30 year fixed has been a norm for a very long time, and the expansion of ARMs and more exotic creative financing instruments in the bubble leading up to the 2008 finance crises was itself a short-term aberration; there was also a brief run up in popularity when interest rates spiked in the 1980s (to avoid locking in sky-high rates.)
The socialization-of-losses aspect comes through interest rates. When wealth isn't held but is traded on markets, there's an incentive to hold interest rates artificially low, because that makes asset prices artificially high. High asset prices benefits all asset holders, so you can make people happier than they otherwise would be simply by keeping rates low.
The bank doesn't care what interest rates are going to be next year, because they sell the mortgage now and collect the cash for it. The buyer cares, but the buyer is probably a hedge, pension, or sovereign wealth fund that in theory at least should be able to estimate & offset interest rate risk.
I wish the article went into more detail about exactly who the losers are in this system. I suspect that it's essentially a policy by the U.S. government to increase social stability (in the form of homeownership, stable residence, investment in communities) at the expense of holders of U.S. dollars and dollar-denominated assets (i.e. most of the rest of the world). In other words, it's transferring wealth from non-citizens in exchange for keeping citizens happy, which is a pretty typical government play. It also looks like the system is on the verge of collapsing, in the sense that it pumps up house prices and encourages artificially low interest rates and high inflation, and hence an increasing number of American renters are being caught on the wrong side of the equation.
People who dont qualify. People who misuse it. As is the case with much debt, there is debt given to people who consume it, spend it, lose it and owe it; and there is debt given to people who invest it, accrue with it, and profit from it. Many people may stumble through the process and benefit from it, while the purchasing power of others who cant get it is diluted.
Interest rates are set in a competitive market. At any given point, there's a relatively fixed supply of money being put into what's on offer.
For buyers like pensions, it's simple: get the highest rate they can with acceptable risk and diversification. Keep in mind that not all of a fund's assets should be invested in super-long duration loans. Anyone running a fixed income portfolio understands this is a major source of risk (interest rate risk) as long-dated bonds are one of the most rate-sensitive investments possible. You'd do better with a blend of short, medium, and long-duration debt to ensure you don't end up hosed when rates move the wrong way.
Also keep in mind, many net buyers of this stuff are using it to offset long-term liabilities -- insurance loss payments, pensions, etc. Insurance companies will adjust premiums based on earnings of their investment portfolios.
And finally, keep in mind that interest rates aren't just a video game. There are major "real" drivers of them, economic growth being one--the demand for credit and its supply absolutely shifts over time, and throughout the business cycle. Real economic variables like demographics, home building, population shifts, the number of retired (more savings) vs working (more wage income) people in a population, etc. cause this stuff to move around a lot. If someone gets a higher rate, it's because at the time, there was more demand for credit, it wasn't just someone "losing" or getting "ripped off" that made that trade possible.
One thing to note about securitization and prepenalties:
The risk of prepayment being priced in, but there is the opposite balance of the fact Mortgage Originators (not the borrower) in some circumstances do have a prepayment penalty; this period is typically up to 6 months after closing.
So, they care, but the risk is (like so many in finance) heavily abstracted.
- fallout risk https://www.investopedia.com/terms/f/fallout-risk.asp
- pipeline risk: https://www.investopedia.com/terms/m/mortgage_pipeline.asp
For the fallout risk an originator can typically model the impact on the value of a mortgage with a conservative low digit basispoint estimate (following past fallout patterns that have been observed for example), for the pipeline risk the originator may do some more exotic price modelling by deriving implied interest rate volatilities from market prices (of interest rate derivatives).
Both risks are relatively speaking minimal given their short horizons and the (current) low volatility of interest rates.
I am impressed with the quality of the website linked to by the author of this thread, great read!
If the consumer doesn't like that they can get a lower cost variable rate mortgage just as easily.
All APR to keep all the payments lower... they lost them all in 08/09.
2006/2007 was when the foreclosures started happening. Interest rates started going up in that timeframe [0], which lines up with the idea that folks couldn't refinance their ARMs into something they could keep paying on; first due to the higher interest rate, and second because the higher interest rate cause their house values to plummet. As these defaults piled up, in late 2007 and early 2008, the banks who later folded realized that their portfolios were not really salvageable.
It is.
> The rate is fixed till the renewable period, typically 5 or fewer years.
Lenders and mortgage brokers will often heavily push loans like that, ARMs with a short initial fixed period, using the (usually slightly) lower initial rate and the prospect of refi before the float as a hook, but full-term fixed-rate mortgages are still more popular.
Categories > Money, Banking, & Finance > Interest Rates > Mortgage Rates
Unless you're not arguing against the last part of the parent comment...
No, it doesn't. That's a chart of the average annual interest rate of 30 year mortgages, not the share of mortgages that are 30 year mortgages.
EDIT: The Mortgage Bankers Association does regular press releases of stats [0], and in them recently ARMs seem to be 3-3.5% of applications.
[0] e.g., https://www.mba.org/2022-press-releases/january/mortgage-app...
What does that have to do with the ratio of fixed rate to adjustable rate mortgages?
You pay a higher rate for a fixed than a variable, but you get a lot more certainty.
Do people just pay the principal and interest for 30 years?
If interest rates go down, you refinance. If interest rates go up, you hold onto that cheap debt as long as you can. It’s a pretty unique product in that one party (the consumer) gets complete flexibility whereas the other (the bank) doesn’t
In several rounds of house buying and/or refinancing, I’ve never even seen an offer in the US that didn't expressly note the absence of an early payment penalty.
https://www.nolo.com/legal-encyclopedia/when-are-prepayment-...
Or, you "refinance" your loan for a better interest rate after you have paid down the loan some. For example, I bought a house in 2018 and refinanced in 2020. Since my home price has gone up in those two years, and I had also paid some of the mortgage off, my rate was much better since my loan-to-value ratio was lower (basically the percentage of the market value of the home you are borrowing... the lower that is, the less risk the lender is taking, since they can sell the house to get back more than the cost of the loan, therefore it has a lower interest rate) I was able to save a large amount on my payment (went from paying $4700 a month to $3600), although it did extend the term of my loan for an extra two years. However, I doubt I'll be in the house that long anyway.
I believe the average mortgage duration is ~8 years, which is why the ‘mortgage rate’ tracks the 10 year Treasury rate and not the 30 year Treasury rate.
Or do there tend to be clauses that allow full repayment on transfer of ownership or something like that?
Most of us have variable mortgages with less conditions placed upon them.
But for a bank, the government requires them to maintain a certain reserve amount. This is to handle withdrawals that are greater than planned.[0] The current loan value is an asset to the bank and so counts towards the reserve ratio. If the loan value drops, then they will have to sell some assets (probably some of those same loans) in order to raise some cash. Since they're forced to do this when it's disadvantageous to them, and it's likely that other banks are also trying to unload some loans to meet their reserve requirements, they have to offer those loans at a significant discount. Meaning they get even less for them than the low value they had them for.
[0] This is what killed Wachovia. There was a "silent" run on the bank over the weekend in 2008 by wealthy customers transferring out amounts above the then-FDIC insurance limit of $100k. It wiped out their reserves and the government forced a sale.
https://en.wikipedia.org/wiki/Government-sponsored_enterpris...
As I understand, the goal of those entities is to simply lower the costs and increase access to loans to the US public.
The folks who bought the principle payments are very happy to get paid early.
From what I know that's a rare scenario. Stressed asset (i.e., mortgage contract) holder typically sells off that asset to someone else at a discount. The buyers are those someone who specialise in holding semi-toxic assets and know how to make money out of it.
Lenders typically don't want to deal with the underlying assets. It's time consuming and not their speciality. Lenders just want to recoup whatever money they can fast and be done with it.
Maybe you meant this and just wrote it differently, but I'd argue it isn't that it is worth less so much as its liquidity has declined. You felt good enough about that 5% at the time you bought out the mortgage, but now it isn't as good a return as you would get if rates were at 10%, thus it may be difficult for you to sell that mortgage off to someone else given their opportunity cost.
On the other hand, rates (at least in the US) are unlikely to jump even a full 1%,let alone 5%, in such a timeline that you couldn't retrench if you believed you were better off to liquidate and move on to higher yielding assets.
Lower liquidity would show up as wider bid/ask spreads, which doesn’t happen in that case.
After being debt-averse my whole life, I finally got a mortgage in 2020 when the prevailing interest rate dropped below the expected inflation rate. Because that meant real rates were negative, and sure, I'd love to get paid for taking out debt. At least so far, it's been a great trade, with me paying 2.75% on my mortgage and my home's value up about 35%.
Out of morbid curiosity, I'd like to know who I'm screwing over. Somebody out there is getting a 2.75% cash flow in a 7% inflation environment. Is it my mom's pension fund? The Saudi sovereign wealth fund? Wells Fargo? The Federal Reserve, and hence everybody who pays for goods with dollars?
Now imagine actually having a mortgage with an interest rate that was negative:
* https://www.theguardian.com/money/2019/aug/13/danish-bank-la...
Ahhh, there it is. So they probably just make Central Bank finance their fees, using borrowers as a conduit. Clever.
[1] https://www.bogleheads.org/wiki/Three-fund_portfolio
[2] https://investor.vanguard.com/mutual-funds/profile/portfolio...
The interest represents the time value of money, which may be different to each side.
Maybe the other side thinks that the 7% inflation is just a short spike over the duration of the mortgage.
Maybe they would like to get USD in the future from a stream of USD denominated mortgage payments if they think the dollar is going up relative to their own currency.
Aside from the time value there may be other reasons, too:
Maybe there are regulatory reasons forcing them to buy a certain amount of mortgages or bonds to diversify across asset classes with different risks.
Or maybe it is just their own diversification strategy to do so.
Financial risk relates to how much the value of an asset changes over time (its variance) so in many cases holding “too many” high-growth stocks in a portfolio is beyond the risk appetite for many investors. Lower yield more stable assets are desirable to balance this.
There are no situations in which every participants wins. There are always "losers" as long as there are finite resources.
Like you said, both participants in the mentioned deal could be profiting, but there are more participants involved on the open market which are affected.
The "losers" are often hard to determine, as the previous commenter correctly pointed out. Nonetheless, the wealth came from somewhere. If it really was "created" from the interaction then this creation causes inflation, effectively removing wealth from everyone holding the currency in which the money was "created".
It's true that this particular deal will have a miniscule effect, but in does matter in aggregation with everyone else that made similar deals.
Macroeconomics is a much more challenging topic then you seem to realize
How about the comparative advantage that Ricardo developed in 1817? https://en.wikipedia.org/wiki/Comparative_advantage
It's true that people can gain efficiency with specialization for example, but that's not necessarily a gain unless you define efficiency as the primary goal to be achieved.
This gained efficiency will then over time make this the most economical way to produce. This effectively harms everyone that hasn't adapted yet
It's just not an easy topic and claiming it is doesn't help whatsoever
Nor did I ever claim that it was Zero Sum at any point. I just pointed out that there are, by necessity, always "losers". That doesn't make it a zero sum game, as the values can be different and have very confusing side effects.
Edit: I flatly reject the notion that strictly someone's gain requires someone's (non-proportinate) loss, ie that there are always "losers". That notion is also not really a current macroeconomic position.
Presumably what you're referring to is that in a realistic market, there are also tons of other people who are willing to swap their wares, and maybe they'll offer me something better for a gallon of water than a pound of meat. So sure, I could be taking a sub-optimal deal by trading with you at the rate you want. But the trade is still positive-sum, no loser in sight. In an efficient market most trade is net beneficial to everyone and doesn't necessarily have losers, including when you start layering in credit and derivatives and inflation and velocity of money and whatnot, even if it gets really complicated. That is possible because we all have slightly different self-valuations of money, goods, and risk at different scales, and the markets let you trade each for the other until you've self-optimized your portfolio blend.
That's not to say you can't come up with scenarios where there are unambiguous losers, but it's definitely not some law of economics or anything like that.
> it's definitely not some law of economics or anything like that.
This is a no true scotsman fallacy. It's true that this is not a preordained truth, but you'll realistically always have someone at a loss for as long as resources are limited. And if you can't see one than you're just ignoring the one's at a loss as irrelevant.
I.e. descendents with natural resources or even non-human entities in the context of meat production etc
> Somebody out there is getting a 2.75% cash flow in a 7% inflation environment
Everybody with cash savings, I guess. Savings rates are abysmal for a while now. Otherwise, not sure.
Mortgages are generally securitized. High level, a pool of unrelated mortgages (think different parts of the US, different types of borrowers, different credit ratings) are packaged up together and then split into different tranches. Say you have tranches AAA-B. These different tranches are sold to different parties with different risk appetites.
Each tranche has a set interest rate, and AAA will have the lowest, and B the highest. Say like 2.5% for AAA and 7.2% for B. AAA is the most "senior" and B the most "junior".
When borrowers pay back their monthly payments, first the interest gets distributed to AAA->B, then all the excess goes back paying the principal of AAA. Once AAA is fully paid back (say 5 years later for a 30 year loan), the AAA bondholders no longer care about the mortgage, and the excess gets paid towards AA principal (then A, BBB etc). This keeps going on until every tranche gets fully paid back.
By structuring it this way it's "almost impossible" for the more senior bondholders to realize a loss.
Obviously there is more risk for B bondholders (given they are being paid 7.2% interest). So in this case, losses in mortgages are borne by B principal holders until they get exhausted.
Zooming back into the pre-payment risk, it's entirely possible that prepayments/refinances will allow the more junior tranchess to avoid as much principal loss as expected while picking up that juicy yield. (note when the yield for more junior bonds are 7.2%, anyone buying these already planned for some amount of realized losses)
This pic from wikipedia illustrates some of the concepts https://en.wikipedia.org/wiki/Tranche#/media/File:Risk&Retur...
For #1, see the section headed "The risk of non-payment". Prior to the mortgages going into the pool, insurance against default is purchased from a GSE. In exchange for this insurance payment, in the event of default, the GSE buys back the mortgage for the remaining principle balance. So as an investor in the typical MBS, you don't face this risk.
For #2 and #3, while it could go into it in more detail, this is discussed in the section titled "Every other risk you could imagine, of which there are many". It notes that the value does change as a result of interest rate changes (in the context of noting this as a key reason why most mortgages are not held by banks, but other institutional investors which can better tolerate this interest rate risk).
There's no way to properly do this.
It's why 2008 occurred, and why it'll occur again.
BTW this is a good overview of different parties involved in the mortgage supply-chain https://imgur.com/NYg7G4t
I somehow didn't quite realize MBS purchases had resumed with the Fed's COVID response, for some reason I assumed they were only buying Treasuries.
Even though I've been trying to keep up with the Fed's activities, somehow I missed the part about current-decade MBS purchases (and it's a big part).
More about why the Fed stepped into the corporate bond market to provide liquidity in 2020: https://www.brookings.edu/wp-content/uploads/2020/10/wp69-li...
But of course the precedent has been set, which may be why you chose to use the present tense.
If you are a numbers person I found H.4.1 weekly data release to be very useful [1]. It is reasonably accessible to non-expert like me so I dig into it once in a while.
The line item of interest here is "Mortgage-backed securities". As you can see from Jan 6th release; Fed funded B576$ worth of mortgages in 2021 alone.
I read remember reading somewhere that Fed now holds 1/3rd of all the mortgages. Can't dig up the source now.
I.e. to keep housing prices high?
It is surprisingly expensive to build a (brick and mortar) house to 2021 security, energy-saving and quality standards, at least in Central Europe. We have a lot of cheaper housing from the 1960s-1980s, both block of flats and detached houses, but no way would such buildings in their original form be approved today.
Or you can save up $1000/mo. for 15+ years so you can pay for the house without taking out a loan… while also paying rent on top of that.
If this link is broken, the U.S. would almost immediately fall into decline. The net spending power of most Americans would drop by a third to one half of what it is today, leading to social unrest. The U.S. government wouldn't be able to fund many of its programs, such as Medicare and the DoD would need to drastically cut its budget.
Mortgages seem to have some pretty nice features. They help encourage people to invest some of their income into an asset that generally appreciates rather than spend it all. It aligns incentives around upkeep and investment in the neighborhood and community. They offset some of the negatives of inflation.
Mass ownership of appreciating assets is a very unstable situation, and also unclear what it even means. It is better to increase wealth through public goods.
We have intentionally sabotaged the ability for our youth to afford houses under guise of safety while simultaneously grandfathering in our own shitty run down structures that were built under much looser requirements. The result is land with a shitty old structure can be worth almost as much as a new one, under this restrained and captured supply.
A smart first time owner will take advantage of this and effectively create an additional 1 or 2 living units (Primary residence+JADU+ADU) that can cover the new mortgage.
Honestly, I agree with one of the quoted people that ADUs are just a political hack to get a half-measure by the NIMBYs.
Even if we converted all the garages it would an extremely inefficient way to construct more housing. There was talk of trying to do financing for poor people to do the conversions, but insofar that that works I think it is likely to push up construction prices because ADUs are so inefficient.
(Conversely, the externality of decreased parking is quite good. I don't want to neglact that.)
If we really care about housing and equity for the poor, we should allow poor homeowners to trade in for a new condo if the entire block agrees, and then redevelop it at a massive scale. Far more housing, still equity for them, and once you bootstrap the process no one even need be displaced out of the neighborhood. Win-win
It's very clear what it means - inflation. Consider a farmer in Zimbabwe who buys a used truck for 10000 Zimbabwe dollars to bring his produce to market. A few years later, he sells his truck for a million Zimbabwe dollars. He is a millionaire! But he still is a farmer and needs a truck to move his produce. Another used truck would set him back 5 million Zimbabwe dollars.
It can't go on like that. At some point the chunk of money that shelter takes out of the monthly paycheck can't grow further.
Cashing out comes with the hassle to move, and is less attractive during pandemic. Rich people that want to decamp boost up demand in the select few popular remote places. That was the 2020 story.
Recently I am less sure exactly what's going, but yeah, single family homes are the worst!
The rest of the inflation is due to pandemic-related supply side dysfunction, and fossil fuels which are even more subject to random things like OPEC whims.
Raising rates to bring down SFH prices and not reforming the SFH system would be colossally stupid.
If you are trading up, the house you are buying is more expensive than the house you are selling. In this case you want a down market. Yes, you get somewhat less for your existing house, but you more than make up for it in what you save on the new house.
If you are trading down, the opposite is true. A hot market has increased the value of the house you are selling more than the house you are buying.
Yes I absolutely agree, the greater extent "homeownership is a middle class right", the more housing price rising just is an across-the-board inflation. To the extent that the poor / non-whites are not involved, it is stealing from them.
This is why fixed asset ownership is just a rotten scheme, inflation or theft, nothing good comes from it.
"store of value" is highly overrated. Public goods and infrastructure are what materially derisks the future. Not some bidding rat race.
- the floor rent is too damn high, but the land rent is two damn low
- Ownership is very hard to price, but the existance of the instutition of ownership is a choice! By raising the land rent the price of ownership shrivels up, and that clamps down on the risks from this volatile and ill-defined problem.
- Rent is just better, what is bad is rent paid to owners, integrating the flow into the stock. Rent that cycles right back around as citizen divdend or gov services stays as a flow and is good. (And what ever evil inclinations states might have, profits are not one of them in the fiat era. (States == federal government in this case. State, local, and invididual departments could still be money grubbers.))
I see you've never rented before.
Landlords maintain power through the restriction of supply. They don't need to actively do it, the single-family-home complex does it for them.
Land value tax (+ land use regulation reform) demolishes that. Appartment management, divorced from land speculation, will become the boring low-margin business it deserves to be.
The modern world of people moving and upgrading every 5-10 years has really changed this dynamic for the negative.
“take care of your local community” and “[preserve] the status quo” are placed in fairly direct opposition often in daily life. unless you want for children to live in the home they were born in forever, no new infrastructure to be built, etc. who really wants the status quo anywhere to be maintained for 30 years? most people i know, most communities i’m involved in, crave more novelty than that.
Relatively slow improvements to living conditions are fine, as that does not cause massive disruption for the average citizen and does not threaten whichever groups are in power.
https://www.medicaidplanningassistance.org/medicaid-look-bac...
California is also phasing out the asset test, which will eliminate the need for a look-back period entirely (asset limit moving from $2k/$3k for individual/couple to $130k/$195k this July, planned for total elimination by July 2024.)
In most states, your home is exempt (at least to certain far above median value, equity limit) from the Medicaid asset test, so, no, you probably won't.
Older families should strongly consider placing their home into some kind of trust or transferring ownership to a descendant before this becomes an issue.
You really want to have a plan for your primary home before this becomes an issue. The asset test is only one concern.
>> certain Medicaid benefits
You get charged $5K/month until you are broke. Then Medicare pays the place 1/3 that price for the same care.
Largest wealth confiscation scheme ever seen. Inheritance? No, sorry.
Medicaid is for the destitute so of course you need to spend down assets to access it.
And if it is worth $100B, would it still be irrelevant? Would they still live in it, instead of selling and becoming mega rich billionaires?
One of the big advantages of a system like the US (unlike, say, Japan, where homes are a depreciating asset) is that it increases mobility. If your home is worth less than the day you moved in, you're kind of stuck there -- every move represents a capital outlay that is just going to evaporate over time. In the US system, a home is a little like a fixed-income asset. Even if it only appreciates at the rate of inflation, you can treat it as a stable store of wealth.
Even if you purchase one home in your entire life, it's still a positive in this system. As others have pointed out already, you can borrow against that wealth, or, in the case of your grandparents, pass it down to heirs. Accumulating wealth is better than not accumulating wealth.
On the majority of lots in most cities it's very difficult (or illegal) to build new housing. That's a regulatory constraint that has nothing to do with how the house is financed.
In the US (and probably most places) a house is the most expensive asset that a person will own throughout their life.
It is reasonable to ask if a person's life would be better if they were able to extract some of the value from the house in exchange for other things. For example, I can borrow against the value of my home and afford to go on more vacations, or a nicer car. It could fund my retirement, even.
Another way of looking at it is as a component of an overall portfolio. Does it make sense for me to have 80% of my net worth in real estate when I can get a 30 year loan at 2% or 3% and diversify? HELOCs are another commonly used instrument.
I suppose some may argue that a few of the things I've mentioned are "irresponsible", but the truth is that it varies from person to person. When used intelligently, debt like this can be a win for both parties.
Isn't this a reverse mortgage?
Edit: now that I think about it. The first level is just buying house with cash immediately. The mortgage is the next level of complexity, adding time dimension. The article is about the 3rd level complexity above that (securitization of the 2nd level)! Turtles all the way down.
US home owners use mortgages for the same purpose as people in other countries... to be able to pay off their home over time. How is it any different as a home owner in the US verse the rest of the world?
Even if you never use it as an asset in your life, it is still an asset.
It seems TFA doesn't address commercial mortgages at all.
A common use for such a loan is to pay for renovations, which can further increase the value of a property. Another typical use is "home grown leverage" i.e. using a home equity loan to pay for some investment, which is commonly done with rental properties (often to make the down payment on another mortgage; the hope being that you can collect enough in rent to have money left over after making monthly loan payments). For a truly US-only use-case, people sometimes wind up having to use a home equity loan to cover medical bills after a major emergency or accident, though I think this was more common before the Affordable Care Act and will probably become even less common with surprise billing being mostly eliminated.
Assuming the standard US fixed 30 year mortgage, it mattered quite a bit. Their final payment was on relative terms, much less than their first payment. This effect over time made your grand parents wealthier by having one of the most expensive parts of living (housing) somewhat sheltered from inflation (taxes and upkeep not withstanding).
I live in a popular location, and the house next door just rented for 2.5x what I pay on my 10 year old mortgage. I like where I live and don't plan on selling, but the price I locked in years ago has absolutely mattered to my life.
If you have 1m equity, you could for example take out 500k at 3% interest and buy a dividend stock paying 6% and effectively double your yield on that equity (plus added risk from the debt, though).
Or use the equity to buy a rental property.
But most people aren't too finance savvy so you're right that it may not affect them in practice.
Just curious, what dividend stock do you think will pay you 6% without very high risk?
The closest I can think of to what you're describing is BP stock but with the recent rise isn't hitting 6% anymore. (I-Bonds are capped at 10k + 5k per year and typically aren't that high.)
Depends on the way the financial sector works where they live; in the US, if they ever applied for credit for anything while owning the house, it, and their debt:asset ratio, probably would have played a role in the terms they were offered, and that may have been largely transparent to them, because a lot of the information flow supporting that decision doesn't go through the people applying.
If the price of your house increases, the price of the better one increases even more. You can switch it if you saved or if you life improved. The price increase doesn't help, it hinders that change.
The way I’ve seen markets move is that certain price bands are more susceptible to fluctuations than others. For example, over the course of a 4 year period you might see the entry point for the market go from $400k to $500k, while the $500-$600k band sees a 30% increase, the $700-$800 band sees a 20% increase, and the $900-$1m sees a 10% increase.
So while the entire market is moving up, certain bands become more affordable if you can capitalize on a higher percentage band.
Be thankful that it didn't. But if they have full ownership, if all their other retirement savings went away, the equity of the home could be leveraged for living expenses:
> This is an “if all else fails” enhancement that Vettese (and I) hope will not prove necessary. For many Canadians with substantial home equity, it’s nice to know that in a worst-case scenario, your home equity can be tapped. But, Vettese warns, “it should only be used to provide necessary income, not to enhance one’s lifestyle.” He also says it should not be considered until age 75. He notes that a reverse mortgage typically involves about 180 basis points higher than a HELOC would charge.
* https://findependencehub.com/retired-money-boost-retirement-...
If someone lives long enough that they are no longer able to take care of themselves, and it is not possible for them to live with family, then the equity could be used for paying for an assisted long-term elderly care facility.
So homes have appreciated strongly in real terms in the last decade, but it's likely they will revert to the mean from here (whether it be quick or more drawn out).
However you're correct that historically homes mostly follow inflation, and aren't appreciating in real terms. It's only in the modern era where that trend has changed, probably due to more investor involvement and Fed trying to stimulate growth aggressively.
But it's important to note, even if a home appreciates only at the rate of inflation, usually the buyer only puts 20% down, so from their perspective they are earning 5x the rate of inflation in equity.
Pretty lucky to those that lived in 10% interest rate times that were able to buy all sorts of property cheap and refinance at low rates later.
Modern homes are typically an improved product, better features, and also better environmental facilities. Thus they should be increasing beyond inflation.
Owning makes you responsible for things beyond your control. If the factory in your town closes, you're underwater no matter how smart you were about picking it or diligent you were about maintaining the house.
Similarly you can't really do what you want with it. You better keep it cream and beige coloured! And that's all you can buy. No one builds small homes or castles. Just identical units. Everyone must have a lawn, it must be one of three shades of green and cut correctly etc.
It also forces you to care about things you don't really care about: you have no problem with minorities living next door, but what if it effects your house price? The same for infrastructure your town needs. You know we need a free medical clinic but what if poor people hang around when you're showing the place?
It has the same effect on services: tax rates MUST be lowered because you can see them before buying. Internet speed is irrelevant because no one knows how bad it is until they move in. So no one has workable internet. Americans schools are famously underfunded for this reason too.
It gives you a big incentive to veto all future housing development too. That's given us a very big housing shortages in many places.
The ownership model also makes people much less mobile, limiting their income and productivity, not to mention cementing inequality and effecting nation gdp etc.
Don't ever buy in a HOA area! That is the nightmare you describe.
No HOA in our neighborhood, so while all the houses were the same shade of beige with the same lawn when the developer built the area, over the years as people have repainted and redone yards it has become wonderfully colorful with each house having unique character.
The only logical reason for this I can see is people being terrified they'll lose 50k because their neighbours paint their house black and let the lawn turn to scrub.
Weirdly you can do what you want outside of that. So I can't build a turret on my house. But I could paint it pink and replace my front lawn with cactuses or cover it in junk cars.
No one can make me do anything to make it look nice. But I'm stopped from doing much to make it bigger or look better than the neighbours.
There are "listed" buildings (where you cannot change almost anything). But they're rare and you know you're buying Shakespeares cottage and gave to keep it exactly as is. And in a lot of areas you need permission to cut down trees over a certain size.
It's a series of posts from a lifelong banker about all of these details, from the 2007 timeframe. Super interesting deep dive.
I disagree with this hyperbole (part of the overall tone of the article). I think taking on full-time college tuition at age 19, or having kids, are both far more complicated and consequential financial decisions.
Taking out a mortgage to purchase, let alone re-finance, an owner-occupied residence is something a lot of people do, perhaps more often than they buy a new mattress. If you have the minimum down payment and good income & credit report, it's not a big deal, and since there are a lot of legal protections all around for owner-occupied properties, it's straight-forward and low risk to the one taking out the mortgage.
>A mortgage has a quirky little subcomponent called a Mortgage Servicing Right (MSR). Every month, it needs to collect money from the borrower and send that money… somewhere. This implies, minimally, a mailbox where you can send checks, someone to open the mail, and a phone number with a CS representative who can answer questions like “What is my current balance?” and “Did you get the last check I sent you?”
I thought mortgage payments were mostly done electronically now?
At the particular mortgage broker that I have inside knowledge of, their worst loan officers are closing 5 loans per month and their best are closing 30 or more which gives them an annual salary of between $400,000 to over $2 million.
10 year fixed rate contract, loan of 1 million and the rate falls from 3% to 2% on the second day of the contract -- if you terminate the contract now, you owe the bank 1% of the sum of whatever your loan balance would have been during each of the next 10 years.
To be fair, you get the opposite deal if the interest rate rises.
Better to go to a broker who shops your loan among dozens of lenders to find the best terms. You typically end up with some entity you've never heard of (not a known bank), who will hold the loan for a month or two and then sell it off to someone else.
For retail mortgages there are presumably regulatory considerations as well, eg, the mortgage probably has to continue to be serviced by a regulated entity. It's not uncommon for the original lender to sell the rights to the mortgage but continue to service it.
This means you'll renew your mortgage roughly five times before it is repaid, at the prevailing rates at that time. There's no such thing here as a mortgage with fixed interest rate over 30 years like, as I understand it, there is in the US.
This sounds a lot like ARMs aka balloon mortgages. Mortgage brokers ramming these everyone's throats played a big role in the 2008 melt down.
So, to the extent that mortgage terms were a factor in the crisis, and I don't know whether it was, I wouldn't say that this kind of mortgage was disproportionately worse.
Lenders were equally complicit in this mess. They were approving borrowers for obscene amounts of money by calculating qualifying amounts using ONLY the initial ridiculously low interest rate of the ARM. Thus, purposefully not accounting for the inevitable rate hike. Most lenders also looked the other way when brokers were very obviously fudging loan applications to qualify borrowers for more money.
When those balloons finally popped (2-5 years from loan inception), home owners saw their monthly payment rocket up to unsustainable levels. This is what kicked off the wave of foreclosures (and why you often hear idiots, even right here on HN, blame the home buyers for the entire housing bubble).
Then there was the whole bundling of these ticking-time bomb mortgages into securities that got magically AAA rated and pushed into people's retirement funds. And also how banks insured these shit securities to protect themselves from what they knew was about to happen. But that's a whole 'nother story that goes beyond the mortgage aspect of it all.
Sorry for the history lesson!
What about the Fed? It is not private capital.
Many lenders refinance loans because lenders also need to finance their activities and refinancing through securitization is a profitable way to do so, that goes for student loans, business loans, private loans, car loans, ...
Mortgages are no exception, what is different about the US compared to Europe is that the capital market to buy packages of loans is more developed because unlike the EU, the US is a unified financial and legal system under federal governance.
What happens in a mortgage is not that much different than a car loan, you use some cash and borrowed money to pay for the car and the lender expects you to repay that money (and interest) in fixed installments. Should you fail to pay the loan then the car is repossessed. The lender will want to make sure that your monthly salary is enough to cover the payments and that the car is valuable enough to recover the principle of the loan should something happen.
Incidentally, this is why banks don't like to give entrepreneurs mortgages because entrepreneurs don't have stable income (usually).
The moment you borrow that money, it becomes a liability for you but it becomes an asset for the bank/originator; after all you are going to pay the originator cash for 25 years.
Now in the US, your originator can sell this asset onwards to a loan aggregator (Fannie Mae; Freddie Mac) to realize profits today rather than hold the mortgage forever but obviously the loan aggregator has some standards it wants you to adhere too. (note: the EU doesn't have these types of loan aggregators due to the lack of synchronization between their national financial markets)
In theory the originator can make more profit by holding the mortgage, but since his money is locked up for 30 years in the mortgage; many of them don't have enough cash on hand to just lend the money and wait 30 years for it to come back so it can be lended out again.
The loan aggregators on the other hand buy mortgages from all originators and can put them together into a package that is safe and diversified enough so that the repayment performance is predictable enough (ignoring pre-2007 when rating agencies succumbed to customers' pressure to rate pretty much anything as safe and caused the huge financial meltdown when borrowers started to predictably default) and sell it onward to pension and sovereign wealth funds.
These aggregators, or GSEs as patio11 calls them, are private companies but by now they are government owned because they all collapsed in the financial crisis and since they underwrite pretty much every mortgage in the US, they had to be saved as otherwise the mortgage originators would also become illiquid and then you can only buy a house in cash (which would have pretty much destroyed the entire housing market in 2008).
The 60 basispoints though, is the fee for packaging the loans. It's not an insurance like patio11 says.
Operational work like support, collections, negotiations about late payment and administrative work ("Servicing") is outsourced is just because no loan aggregator wants to deal with that and a pension fund DEFINITELY doesn't want to deal with that and like any outsourced service that is well-understood, they prefer to pay as little as possible for this part. This creates natural market pressure for consolidation.
(we don't do much in the RMBS area specifically)