Thursday, September 23, 2010

Why Climbing Rates, in the Current Period, Are Unlikley to Crash the Value of Your House

Whenever I post on the current low level of interest rates and advise that it is an okay time to buy a house and lock in rates, I will get arguments from those who contend that climbing rates will result in lower housing prices.

This, indeed, does occur at certain times in the business cycle, specifically when rising rates slow money growth. When money growth is slowed, there is simply less money around to buy houses. But to look at the absolute direction of interest rates to determine housing prices is faulty.

Interest rates right now, for example, are at multi-decade lows, yet there is no boom in the real estate market. This is because, although rates are low, the Fed is not creating any money that would push housing prices higher.

The most likely scenario under which interest rates will go up in the near future is as a result of strong demand for borrowed funds by the Treasury. As the rates climb from Treasury borrowing (Remember it appears that the Chinese have stopped buying Treasury securities  and the Social Security Trust Fund that bought up  to 25% of Treasury issues in past years is now a net seller), the Federal Reserve will step in to buy Treasury securities to slow the interest rate climb, when this happens the system will be flooded with money causing price inflation across the board, including housing.

The inflation-adjusted housing price won't climb, but the nominal price will. This means that anyone buying a house at that time will have to pay the higher price for the home, plus the higher interest rate.

What would you rather do, buy a million dollar house now and lock in 4% or be forced to pay a million and a half for the same house and pay, say, 10%. in a couple of years?

This is a no brainer. You buy and lock in the rate now. When the inflation hits, your monthly payment will be chump change.


  1. I purchased my home in 1980 when rates were 14 percent. Nobody was buying at that time and I negotiated a good price. I believe it was the extremely high interest rates that kept house prices low in 1980. This is completely opposite to what you are now claiming.

  2. My take, as an ex-financial analyst for a residential real estate developer: the monthly amount that the purchaser has to pay has a much greater influence on the buying decision than the price of the property. All else equal, as rates go up, the price has to come down to maintain the same monthly payment. I believe the point of this post, though, is that all else is not equal. As new money is created and becomes available to spend, the amount per month people are willing to pay will increase. It seems to me that changes in nominal price will be determined by whether the upward pressure from inflation offsets the downward pressure from rising rates. I believe that once inflation gets going, it will and we'll see a rise in prices. However, I also think there's a reasonable chance we'll see another leg down first.

    All of this, however, ignores opportunity costs. In Seattle, I can rent a comparable house/apartment for much less per month than I can buy one. How long until inflation causes rents to catch up to the mortgage? If real estate goes up in nominal terms but down in real terms, is it better to put the extra money spent on the mortgage payments (not to mention the down payment) into gold/hard assets that would see even larger price increases?

  3. unless wages increase or somehow people earn or get hold of that extra printed money u talk about, i dont see how there will be buyers at those higher prices.

    wages have been stagnant for over a decade...i dont see them increasing anytime soon - unless there is inflation in general and the companies have to raise pay.

    i guess they can loosen the credit/loan standards again and try causing bubble again, but i doubt how far that will help. Its only so much anybody can raise debt...there is a limit, and we are way past it for average family.

  4. Will we get inflation or hyper-inflation? Will banks keep accepting $3,000 monthly pyments when they have to somehow pay tellers $300K a week? The USG would not allow banks to go under due to non-payment of P&I, so how will it intervene when fixed mortgages in real terms yield next to nothing? In moderate inflation real estate is a good hedge, but as a factual matter was real estate good in Weimer or Argetina. People who bought in Japan bubble are not exacttly benefiting from their low mortgage rate. I think it is too risky to try to play this. If it were a sure thing it would make sense to leverage up to the biggest home you could finance and I think that would be suicidal now.