Middle class homebuyers taking $7k mortgages planning to later refinance down

I liked the last line the most .. I think we've all gotten accustomed to zero interests, and this has changed our behavior. My father to a large extend screwed up his (and our family's) life because he lived in an era of high rates. He did not understand the world had changed. We could have bought a house for cash in 1995 but he chose to rent. After that, it was always a bubble, with no buying opportunity like 1995 ever.

It makes me wonder if all of us have similarly not realized the world is a different place post rate hikes. There is this inevitable dogma that "rates will go back down". A lot of people are making that bet and I wonder if it is just history again.

What I don't understand is what is driving the US economy today. It seems to be firing on all if not most cylinders. People I know who got laid off are finding work (I hear negative experiences too and feel for those people). Hiring in tech seems like it is picking up.

I believe the US mortgages work because of Fannie Mae/Mac and a market in mortgage backed securities ( MBOs? I thought they caused the 2008 crisis but I think they are still a thing with better risk management, I dunno?).

Not really. Mortgages are (mostly) bundled and on-sold to investors which assume the risk of default and interest rate changes. The originating bank collects are premium for the loan and moves on to the next one.

Refinancing happens when rates go down.

Yes, this does mean lenders take a lot of interest rate risk. The whole US government mortgage securitization and insurance infrastructure exists to help transfer this risk to people who want it.

More in this classic Byrne Hobart essay: https://byrnehobart.medium.com/the-30-year-mortgage-is-an-in...

It is and it isn’t I think. They rebundle those into securities and sell them on so that other banks and investment firms convert capital into cash flow and it acts like an investment portfolio (then others leverage those securities with derivatives). So the bank isn’t holding the loan directly typically. Of course, as we found out in 2008, the amount of exposure to risk is generally poorly understood even by the players. That being said, I believe similar things happen abroad, so I’m not so sure why 30 year fixed exists in America as an anomaly that you don’t see in other countries and what specific regulation / law encourages it to be this way.

People actually do refinance frequently if rates go down. If they go up naturally they'll keep their lower rate.

This does create issues when rates go up a lot like they just did, because it makes it harder for people to move.

Fixed rate mortgages do create risk for banks, and some banks have run into trouble recently, although a lot of mortgages are resold by banks and packaged into bonds, either by investment banks or by the "Government Sponsored Entities", Fannie Mae and Freddie Mac.

https://en.m.wikipedia.org/wiki/Mortgage-backed_security

https://www.axios.com/2023/04/08/banks-retreating-mortgage-m...

You can refinance whenever you want if you qualify

It makes sense when rates go down

U.S. inflation is down to 3 percent in June from a high of 9% last year. You could argue that interest rate hikes didn't cause that change, but interest rates are the Occam's razor explanation.

https://www.usinflationcalculator.com/inflation/current-infl...

As long as lots of people get crushed simultaneously, the banks will demand to be bailed out, too.

A bunch of Southern California homes are already in this state--the banks are allowing the "owners" to simply pay the tax and interest and still live there. Why? Because if they foreclose on just a few too many houses, the basis value will plunge, the "owners" will walk away, and the bank will be stuck with a house they can't sell which will promptly get vandalized.

Only suckers use cash as long as the government keeps bailing them out.

I’ve always believed that if you want to buy a home and can afford it you should buy it. Timing the market is too hard.

Will it make you house poor? Possibly, especially in a place like the Bay Area where many people will risk being house poor to own a home.

If rates go down prices will rise

My home, just purchased 1.5 years ago, would be well beyond unaffordable now. How is that not insane?

Of course the more fundamental question is, should you buy a home at all? And that's a complex decision. But if you do make that decision, sinking significant liquid funds into property instead of using relatively inexpensive leverage is, as a general rule, a terrible financial decision.

For example, if you own a place with a 3% mortgage, you aren't likely to sell it and buy a new place with a 7% mortgage. If you bought a place at $500,000 with 20% down, your mortgage is $1,686/mo. Let's say that prices go down so that a new place at 7% would cost $1686/mo. Prices would have to dip to $317,000, a 37% decrease. After 5 years of owning your home that you purchased for $500,000, you still owe $356,000 on your mortgage. If you sold your place for $317,000 and then bought another place for $317,000, you'd have lost the $100,000 down payment on the first place, need a $63,000 down payment for the new place, have gotten zero equity out of your mortgage payments, and still have the same $1,686/mo payment. So you certainly wouldn't sell for $317,000.

If you sell for $450,000 and buy another place for $450,000, your monthly payment goes up by $527/mo. You need $90,000 for the down payment on the new place and you will have gotten back your $100,000 + $44,000 in equity from the first place so you'll have $54,000 in additional funds. You could invest that $54,000 and try and get a 10% return getting you $5,400/year or $450/mo. That's shy of the $527/mo increase in your monthly so you're still losing money.

So if you own a place with a low interest rate, you don't want to sell.

For people who are on the cusp of renting vs buying, it offers an incentive to continue renting for a few more years. A $750,000 place is $2,530/mo at 3%, but it's $3,992 at 7%. That's $1,462/mo more expensive and a 58% increase in the monthly mortgage payment. Of course, a strong incentive to continue renting puts upward pressure on rents.

Upward pressure on rents in turn offers potential buyers an incentive to pay more to own a place. If your rent is going up a lot, that makes buying a more attractive proposition and you're willing to pay more. The fear that rapidly increasing rents puts into peoples' heads also pushes prices higher.

Even if you own a place and are looking to buy a new place, it can make more sense to rent out the old place given your costs. As noted, there's upward pressure on rents as some buyers delay and your costs to rent the unit are going to be substantially less than someone trying to buy at 7%.

Yes, higher mortgage rates should put downward pressure on home prices. However, there's a lot of other stuff that pushes back on that. Sellers often can't afford to sell if the property is underwater. Even if they're not underwater, it makes more financial sense for them to stay put. It even makes more sense for them to rent out the place even if they're moving because of the good interest rate.

There just aren't strong scenarios for higher interest rates pushing housing prices significantly lower. Sure, the mortgage on that $750,000 place is now 58% more expensive. Not everyone will make decisions the same way, but certainly some owners would rather rent out the place at $3,000/mo than sell it for less and many potential buyers would rather put off ownership for a couple years given the huge increases from the mortgage rates. Some renters will be willing to pay more because home ownership is now more expensive and as rents increase that means that even more expensive ownership opportunities don't look as expensive.

I think the biggest thing is that people don't expect things to continue being bad. They expect to refinance their mortgage so even if rates are high for a year or two, they're confident they won't actually be paying that much over the long-run. If that's your mentality, then higher rates put limited downward pressure on housing prices - while the rest still exert their upward pressure. At some point there's a lot of confidence behind the market. It might be misplaced confidence. Maybe we'll be in 2030 with mortgage rates sticking at 7% and everyone will end up having paid a ton more money than they were expecting.

I will say that there is some evidence of prices lowering a bit in many markets - but they aren't lowering anywhere near enough to overcome the difference in mortgage payments. Again, there's a lot of other pressures keeping prices up (even if they're slightly down). And if most buyers think "it's just a couple years at the high rate so I'll budget $10k to refinance plus $35k in higher payments over two years, $705k is the same as $750k", then we aren't going to see major decreases in housing prices. Buyers "know" (or think they know) that interest rates will come down and so they just need to factor in the extra costs in the meantime. If rent is going up 10-15%, housing normally goes up 2-3%, and the interest rate/refinance cost is going to cost you ~6% of the home's value, then maybe a 0-4% decrease in house prices is the most that makes sense - or even an increase given the upward pressure from rental hikes (if that's happening in your area).

In the 2008 mortgage crisis, owners didn't have the option to stay. They defaulted on their mortgages. Demand was really soft because banks didn't want to lend. Unemployment was high. Today, there's nothing forcing people to sell - in fact, that 3% mortgage rate could be a huge asset to hang onto. Today, the job market is strong and especially strong in many cities keeping demand high. Even the stock market is just at such highs that many people feel like they have money to spend - in 2008, the S&P dropped around 50% so people had a ton less money if they wanted to liquidate stocks for a down payment. There's just a lot keeping prices high even in the face of higher interest rates today. That doesn't mean we won't see some declines, but without more going on it'll be hard to fall too much. There's too much confidence, few sellers, and a lot of demand.

It doesn't. I'm in DC, and prices have basically stayed put give or take a few percentage points. It's obvious why: if you own a house, you're going to be very resistant to taking a 100k+ loss when selling it, especially when the place you might buy is also stuck at a high price and will require paying double the interest rate.

So in practice, housing costs just shot up 40% until further notice for anyone who can't stay put.