Mortgage Rates- Confounding the Sheeple

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

If you wait too long and wage inflation kicks in then the house price will never drop 40%. From 1970-1980 in the UK during the great inflation house prices went from £5000 to £20000 despite high interest rates as wage inflation ran high enough to make up for increased payments.
If the same happens again getting a long fix with minimum down payment now might be the way to go.

Well, I am actually in the process of buying a house at a low fixed interest rate, so for me this has ceased to be a hypothetical choice. Basically, I decided that since I can't rent the type of house I want to live in, and since I can buy such a house for a fixed payment that equals my current rent, and since that payment is affordable... it made sense to lock down a fixed housing cost under terms I can live with. However, I did not want to represent my choice as being optimal from a strict cost analysis sense. It seemed okay from a cost/risk/benefit sense.

For what it's worth, my working assumption is that wage inflation will not keep pace with cost inflation, at least in the US. When inflation hits here in earnest, it will likely be cost-push inflation, and labor lacks the pricing power to keep up. Reduced wage purchasing power in the US is the route by which American consumption will be brought in line with American productivity. Therefore, I'm not counting on having a larger income, even if my living costs inflate.

[don]

Re: Mortgage Rates- Confounding the Sheeple

Should have been "a drop to" rather than of. I edited the original post.

Thanks, Ash.

Our numbers are close enough to show what a significant add that tax deduction elicits.

[Starving Steve]

Re: Mortgage Rates- Confounding the Sheeple

Should have been "a drop to" rather than of. I edited the original post.

Thanks, Ash.

Our numbers are close enough to show what a significant add that tax deduction elicits.

Mortgage interest tax-credit, not only RAISES the purchase price of the home (as a hidden support to the house price-bubble) it also makes the federal deficit BIGGER by denying income taxes to the government. The mortgage interest tax-credit is a double-whammy in the sense that it costs MORE to buy a home and it INCREASES the federal deficit.

So my question is: WHY WERE LIBERALS SO IN-FAVOUR OF MORTGAGE-INTEREST TAX- DEDUCTIBILITY? The end result was bloated house-prices, bigger profits for finance, insurance, and the real-estate industry, more of a debt-burden on home-buyers because of higher home prices that had to be financed, and a bigger deficit burden in the federal government which made spending on really important stuff like medicare for everyone (regardless of age or pre-existing condition) impossible to pass in Washington.

What were the liberals doing in Berkeley, for example? --attending rock concerts and smoking pot? That was liberalism?

This Great Recession shows how screwed-up the leftwing has been for decades!

In several of my letters published in the Colorado Springs Gazette Telegraph (italics), I suggested getting-rid of the mortgage interest tax-deduction as a way to pay for major health reform in Washington. These letters were published in the years 1988-1991.

[don]

Re: Mortgage Rates- Confounding the Sheeple

With the interest deduction amounting to up to a 1/4 add to the price of a house, talk of abolishing it is either 1) smoke & mirrors scare tactics with zero chance of occurring or 2) FIRE wants it. We're acclimatized to the former. It's the latter that's intriguing. What historically unique conditions would make that an attractive change for something that's amounted to a FIRE windfall?

[llanlad2]

Re: Mortgage Rates- Confounding the Sheeple

Well, I am actually in the process of buying a house at a low fixed interest rate, so for me this has ceased to be a hypothetical choice. Basically, I decided that since I can't rent the type of house I want to live in, and since I can buy such a house for a fixed payment that equals my current rent, and since that payment is affordable... it made sense to lock down a fixed housing cost under terms I can live with. However, I did not want to represent my choice as being optimal from a strict cost analysis sense. It seemed okay from a cost/risk/benefit sense.

For what it's worth, my working assumption is that wage inflation will not keep pace with cost inflation, at least in the US. When inflation hits here in earnest, it will likely be cost-push inflation, and labor lacks the pricing power to keep up. Reduced wage purchasing power in the US is the route by which American consumption will be brought in line with American productivity. Therefore, I'm not counting on having a larger income, even if my living costs inflate.

Definitely in your case it makes sense to buy.But I also think it will prove the right choice in a cost analysis sense.
Although wage inflation will not keep up with cost inflation it will nevertheless occur and be significant, hence house prices will still have the potential to go up in a stagflationary period even as interest rates and inflation increase. In this scenario buying a house with 100% cash would be a losing proposition but buying with a large, long term, low, fixed rate mortgage a definite winner. That is certainly what happened in the UK in the 1970s, but obviously the US housing market may be different.

[Munger]

Re: Mortgage Rates- Confounding the Sheeple

I get about the same number.

Initially, interest payments at 5% are around $400/mo per $100k borrowed (well, starts at $416.67 and falls to about $411 at the end of the first year), so I presume the $650 figure factors in $150 in monthly property taxes ($1800/yr per $100k). That property tax figure per $100k seems way high to me, but I'm sure it depends upon where you live.

So, assuming a 25% tax bracket, the mortgage interest deduction would make a ~$150/mo ($162.5) difference to a buyer.

If the buyer's spending power is reduced by $150/mo per $100k borrowed, then at 5%, the impact ought to be that without the mortgage interest rate deduction, they borrow $72k where they would have borrowed $100k. In other words, the full P&I on $72k at 5% is equal to the P&I on $100k at 5%, less $150 a month. In both scenarios, the buyer coughs up about $386 net per month.

So, it seems to me that the buyer is going to be able to borrow 72% of what they otherwise would with the mortgage interest rate deduction, so home prices should drop about 28%. That's close to the figure you cited.

Yeah. If the mortgage interest rate deduction is axed, as in some of the tax reform proposals, that will be a huge deal. Knowing how close to the edge some families live, I have wondered whether Congress could actually make this one fly (unless it is undertaken really slowly). I've also wondered about the combination of higher mortgage interest rates AND reduced/eliminated mortgage interest rate deduction.

A complicating factor is that the mortgage interest deduction only matters if one itemizes. Thus, for most people it just doesn't make a difference -- they will take the standard deduction. The mortgage interest deduction really starts kicking in for the top 10% of income earners. The effects of ending the deduction might be concentrated in higher-end houses (but not very high-end, where the mortgage deduction makes no difference). Here is an article with some nice graphs:

Alex Hart has a good post examining whether the mortgage-interest tax deduction -- which will cost taxpayers $131 billion in 2012 -- is really a "middle-class tax break," as some people like to claim. The answer is no, but it really deserves a graph:



As you can see, the less money you make, the less the mortgage-interest tax deduction does for you. But putting it in percentile terms understates the situation, as 1 percent of a big salary is a lot more money than 1 percent of a small salary. So here's the same graph in raw dollars:



On both graphs, the benefits for the bottom 40 percent of the income distribution are invisible. That's not because they literally don't exist, but because the deduction is worth $2 to people between in the bottom fifth and $32 for the quintile after that. As for the top 1 percent? They're getting a break of more than $5,000. I'm not really clear why we're giving people making hundreds of thousands a year large subsidies to buy a house, but I'm sure there's a good reason.

By Ezra Klein | November 16, 2010; 4:05 PM ET
http://voices.washingtonpost.com/ezr...-interest.html

Calculated risk has predicted a further 5% to 10% drop in real housing prices, taking into account a great number of factors including: case schiller, excess supply, and price-to-rents.

Two weeks ago I posted some questions for next year: Ten Economic Questions for 2011. I'm working through the questions and trying to add some predictions, or at least some thoughts for each question before the end of year.

1) House Prices: How much further will house prices fall on the national repeat sales indexes (Case-Shiller, CoreLogic)? Will house prices bottom in 2011?

There is no perfect gauge of "normal" house prices. Changes in house prices depend on local supply and demand. Heck, there is no perfect measure of house prices!

That said, probably the three most useful measures of house prices are 1) real house prices, 2) the house price-to-rent ratio, and 3) the house price-to-median household income ratio. These are just general guides.

Real House Prices

The following graph shows the Case-Shiller Composite 20 index, and the CoreLogic House Price Index in real terms (adjusted for inflation using CPI less shelter).

Click on graph for larger image in graph gallery.

In real terms, both indexes are back to early 2001 prices. Also both indexes are at post-bubble lows.



As I've noted before, I don't expect real prices to fall to '98 levels. In many areas - if the population is increasing - house prices increase slightly faster than inflation over time, so there is an upward slope in real prices.

If real prices fall to 100 on this index (seems possible) that implies about a 10% decline in real prices. However what everyone wants to know is the change in nominal prices (not inflation adjusted). If real prices eventually fall 10%, that doesn't mean nominal prices will fall that far. House prices tend to be sticky downwards, except in areas with a large number of foreclosures. That is key a reason why prices have been falling for years, instead of adjusting immediately.

Price-to-Rent

In October 2004, Fed economist John Krainer and researcher Chishen Wei wrote a Fed letter on price to rent ratios: House Prices and Fundamental Value. Kainer and Wei presented a price-to-rent ratio using the OFHEO house price index and the Owners' Equivalent Rent (OER) from the BLS.

Here is a similar graph through October 2010 using the Case-Shiller Composite 20 and CoreLogic House Price Index.



This graph shows the price to rent ratio (January 1998 = 1.0).

I'd expect this ratio to decline another 10% to 20%. That could happen with falling house prices or rents increasing (recent reports suggest rents are now increasing).

Price to Household Income

The third graph shows the Case Shiller National price index (quarterly) and the median household income (from the Census Bureau, 2010 estimated).



Once again this ratio is still a little high, and I'd expect this ratio might decline another 10%. That could be a combination of falling house prices and an increase in the median household income.

This isn't like in 2005 when prices were way out of the normal range by these measures, but it does appear prices are still a little too high.

House Prices and Supply

The final graph (repeat) shows existing home months-of-supply (left axis), and the annualized change in the Case-Shiller composite 20 house price index (right axis, inverted).



House prices are through October using the composite 20 index. Months-of-supply is through November.

We need to continue to watch inventory and months-of-supply closely for hints about house prices. Right now house prices are falling at about a 10% annual rate.

Note: there have been periods with high months-of-supply and rising house prices (see: Lawler: Again on Existing Home Months’ Supply: What’s “Normal?” ) so this is just a guide.

My guess:
I think national house prices - as measured by these repeat sales indexes - will decline another 5% to 10% from the October levels. I think it is likely that nominal house prices will bottom in 2011, but that real house prices (and the price-to-income ratio) will decline for another two to three years.

[ASH]

Re: Mortgage Rates- Confounding the Sheeple

A complicating factor is that the mortgage interest deduction only matters if one itemizes. Thus, for most people it just doesn't make a difference -- they will take the standard deduction. The mortgage interest deduction really starts kicking in for the top 10% of income earners. The effects of ending the deduction might be concentrated in higher-end houses (but not very high-end, where the mortgage deduction makes no difference).

Thanks, Munger. I didn't think of that.

[Master Shake]

Re: Mortgage Rates- Confounding the Sheeple

A complicating factor is that the mortgage interest deduction only matters if one itemizes. Thus, for most people it just doesn't make a difference -- they will take the standard deduction.

But if you have a mortgage, you will itemize since it saves you money compared to the standard deduction. It does make a difference, and not just to the top 10%.

[don]

Re: Mortgage Rates- Confounding the Sheeple

Good post, Munger. The deduction is finely sliced and diced already. If, and the idea may just fade away, the tax deduction is eliminated (phased out for existing mortgage payees over several years, etc) I think that's good evidence that there's a new business model in the works for US housing. The wealth creation and distribution that started in the 50s, that made the housing ownership model work, appears over, and with it every wealth draining fee that's attached itself to housing.

[flintlock]

Re: Mortgage Rates- Confounding the Sheeple

Basically, I decided that since I can't rent the type of house I want to live in, and since I can buy such a house for a fixed payment that equals my current rent, and since that payment is affordable... it made sense to lock down a fixed housing cost under terms I can live with. However, I did not want to represent my choice as being optimal from a strict cost analysis sense. It seemed okay from a cost/risk/benefit sense.

This is the best reason for buying. Getting what you want vs what is available in the rental market. For many, renting is just not an option unless you expect big drops in housing. While i do think housing will continue it's slide, I think the worst of it is over and inflation will soak up some of the drop. With a fixed mortgage, you will reap the full benefit of that inflation by buying now. I think more practical considerations like your's outweigh any financial ones at this point. We are talking chump change differences compared with what this discussion would have been a few years ago.

I will say as far as the links showing interest rates to have no impact on housing prices, I don't think those links really proved their point. Rather thin on details. I'd like to see a chart of the economy transposed on to the graphs. Would the prices have dropped more in the 80s if the economy and population had not been growing so? And like others mentioned, typical debt ratios were different then. I'm always wary of trusting historical economic information when only a few variables are shown. It can be just too damn misleading.

I think common sense has to play a role here. Interest rates double, payments virtually double. Where does that extra money come from? The real factor regarding housing prices is going to be unemployment. If unemployment doesn't drop then wage inflation ain't happening. Today's interest rates are artificial. They don't reflect true market forces. The same cannot be said about unemployment. If anything it is higher than stated. I'd say there is a greater chance of Interest rates rising than employment. If you believe that then you must believe rates affect housing prices. It really is a "monthly payment" world. Most Americans today don't have much wiggle room on a month to month basis. With such low down payments, minor changes in rates really dramatically affect the monthly payment.

Of course the price range of homes is a huge factor in all this. I believe Americans will be seeking more modest homes in the future. If just due to rising taxes and energy costs. This could bode well for modest well built homes in good areas, while leaving the McMansions and older poorly built homes in fringe areas in a bad way.

[globaleconomicollaps]

Re: Mortgage Rates- Confounding the Sheeple

Here's a calculation I made recently.

Scenario #1: Buy house during generational low in mortgage interest rates, but pay higher real price than likely low point. Put 20% down and get a fixed 3.875% rate for 30 years.

Scenario #2: Hypothetically, wait a few years -- fixed 30-year mortgage rates are now 9% and the house price is 40% below Scenario #1, such that a buyer putting 20% down will have the same monthly payment as in Scenario #1. However, I have managed to preserve the purchasing power of my down payment funds, so I can put 33% down rather than 20% down, due to the reduction in house price.

An amortization calculator says that I will pay 16% more over 30 years in Scenario #1 as opposed to Scenario #2, for the specific property I was analyzing.

The above calculation is imperfect, but it helped to quantify some of the qualitative arguments made by Dr. Housing Bubble.

it seems to me that when the rates jumped in the late 70's house prices shot up ( not down ) and there was a rush to "get in while the good deals are still available". I think we are looking at a real ( inflation adjusted ) as well as a nominal bottom in prices soon if we have not seen it already.

Also the concept of a "real" house price implies that you will have income that goes up at the same rate as houses ( cars, food, gas etc ). A house is an inflation hedge.

[flintlock]

Re: Mortgage Rates- Confounding the Sheeple

A complicating factor is that the mortgage interest deduction only matters if one itemizes. Thus, for most people it just doesn't make a difference -- they will take the standard deduction.

But if you have a mortgage, you will itemize since it saves you money compared to the standard deduction. It does make a difference, and not just to the top 10%.

I think we need information on how many people actually itemize. Someone told me once that even with a mortgage, most don't itemize.

[karim0028]

Re: Mortgage Rates- Confounding the Sheeple

This is the best reason for buying. Getting what you want vs what is available in the rental market. For many, renting is just not an option unless you expect big drops in housing. While i do think housing will continue it's slide, I think the worst of it is over and inflation will soak up some of the drop. With a fixed mortgage, you will reap the full benefit of that inflation by buying now. I think more practical considerations like your's outweigh any financial ones at this point. We are talking chump change differences compared with what this discussion would have been a few years ago.

I will say as far as the links showing interest rates to have no impact on housing prices, I don't think those links really proved their point. Rather thin on details. I'd like to see a chart of the economy transposed on to the graphs. Would the prices have dropped more in the 80s if the economy and population had not been growing so? And like others mentioned, typical debt ratios were different then. I'm always wary of trusting historical economic information when only a few variables are shown. It can be just too damn misleading.

I think common sense has to play a role here. Interest rates double, payments virtually double. Where does that extra money come from? The real factor regarding housing prices is going to be unemployment. If unemployment doesn't drop then wage inflation ain't happening. Today's interest rates are artificial. They don't reflect true market forces. The same cannot be said about unemployment. If anything it is higher than stated. I'd say there is a greater chance of Interest rates rising than employment. If you believe that then you must believe rates affect housing prices. It really is a "monthly payment" world. Most Americans today don't have much wiggle room on a month to month basis. With such low down payments, minor changes in rates really dramatically affect the monthly payment.

Of course the price range of homes is a huge factor in all this. I believe Americans will be seeking more modest homes in the future. If just due to rising taxes and energy costs. This could bode well for modest well built homes in good areas, while leaving the McMansions and older poorly built homes in fringe areas in a bad way.

I am going to agree with you at this point flint... If you have the money, and can afford being underwater if/when you want to sell then its no longer an economic decision, its personal and if you wanna splurge to live the life you want, then by all means go for it and who cares about interest rates or inflation or taxes....

A House you live in is not an investment or an asset, its a liability that even when paid in cash still takes money out of your pocket every month (insurance, taxes, maintenance, etc)..... You can make nominal money on it by buying when interest rates are high and selling when they are low... But, buy now and you are at best going to break even after inflation; but that is the cost you pay for that luxury .

But, make no mistake about it... A sure as the sun rises and sets, interest rates will go higher one way or another; they are a market like any other.... If it doesnt happen due to suppression well then there are reprucssions for that in terms of the currency and much better options to deal with it than housing...

But, a mortgage that you can afford at a suppressed interest rate that is fixed is not a bad option if you wanna go that route. Also, one thing to keep in mind that all markets are relative, if you have a house and the dollar collapses by 50%, your house goes up by 10%, food goes up by 100%, silver goes up 600% and gold goes up 400%..... Nominally you can say glad i bought before houses skyrocketed, but are you really that much better?

Most folks only look at housing bc that is what they see or hear on a day to day basis, but very few know about other asset classes or how they are related to each other and will be happy with a 10% "jump" in the price of their house...

[cbr]

Re: Mortgage Rates- Confounding the Sheeple

Make the best deal you can on the place you want to live, and don't be incredibly stupid about that...

I learned these lessons, frankly, there are simply too many variables and moving parts regionally to apply trends (even obvious ones) to your decision on your housing. I rather frantically sold my Houston house starting late 2007 after I moved to another city, based largely upon Itulip national trends and my own perceptions of the Houston bubble being slightly less than everywhere, but still a big bubble.

If I had simply held onto that asset and rented it, I would be WAY ahead today. Houston inner loop never dipped like the rest of the country, and rents went up pretty good due to national lending constraints for potential buyers. I imagine the cost of the suburban commute is so high that pushed inner loop prices and rents way up too. That was me overlooking factors that in hindsight clearly trumped itulip macro data and theories.

Now, I recently locked in a zero down low interest fixed 30 year note on brazos river front acreage and home, (exclusive private river access, and enough acreage to be called a ranch) which is fertile, fun, and pleasant with elbow room, but close enough to Houston that I could ride a bike or a horse if I had to...

I feel I got a pretty good purchase price, and am pretty well situated whether we go fusion utopia or mad max. If I ever DO have to sell, I anticiipate that the acreage, river front, upscale development direction, and low interest rate will work heavily in my favor in an increasing population/inflation environment.... but I wish I had kept the inner loop house and rented it as an ultimate hedge against the possibility of unobtainable or unaffordable transportation energy.

[flintlock]

Re: Mortgage Rates- Confounding the Sheeple

I am going to agree with you at this point flint... If you have the money, and can afford being underwater if/when you want to sell then its no longer an economic decision, its personal and if you wanna splurge to live the life you want, then by all means go for it and who cares about interest rates or inflation or taxes....

A House you live in is not an investment or an asset, its a liability that even when paid in cash still takes money out of your pocket every month (insurance, taxes, maintenance, etc)..... You can make nominal money on it by buying when interest rates are high and selling when they are low... But, buy now and you are at best going to break even after inflation; but that is the cost you pay for that luxury .

But, make no mistake about it... A sure as the sun rises and sets, interest rates will go higher one way or another; they are a market like any other.... If it doesnt happen due to suppression well then there are reprucssions for that in terms of the currency and much better options to deal with it than housing...

But, a mortgage that you can afford at a suppressed interest rate that is fixed is not a bad option if you wanna go that route.

Agree completely. Definitely not an "investment"! I just think for many like Ash, as well as myself, we are at a point where practical considerations
outweigh the financial ones. In other words, buying now vs later won't make that much difference. And from previous posts, I know ASH can afford it. To me at least, in the big picture, buying a house is worth it for the stability. I hate moving and I like the schools my kids are in. I have my home the way I like it. I have a home theater, workshop, etc. Things that are almost impossible to have if you rent. If not for these considerations, I'd be renting for sure. Most people refuse to see the REAL cost of ownership. All those little things that add up.