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Home Prices and Mortgage Rates


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Something I don't completely understand:

 

http://www.calculatedriskblog.com/2010/09/mortgage-rates-and-home-prices.html

 

Isn't it low mortgage rates that set up the whole bubble in the first place?

 

If a couple earning income x can afford a million dollar home at 5% mortgage rate, wouldn't they be only able

to afford a much lower priced home at a 10% mortgage rate? Wouldn't that reduce demand and hence, home prices?

 

It would seem that buying activity is even sensitive to the $8000 tax rebate, the expiry of which is causing the current

dip in activity.

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If a couple earning income x can afford a million dollar home at 5% mortgage rate, wouldn't they be only able

to afford a much lower priced home at a 10% mortgage rate? Wouldn't that reduce demand and hence, home prices?

 

What people can afford and what they will pay are generally different. People can afford gasoline at $8 per gallon, but this does not mean that the price then magically become $8. Part of the problem with the real estate buble is that the thinking was twisted to equate what people could afford, with the price.

 

As a curiosity, the price of gasoline in the country I live in, is a little below $8 - this is why I know people can afford it  ;)

 

Cheers

 

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I disagree with the article. If you keep the price of the house and the downpayment constant and vary the mortgage interest rate, the higher the rate the higher the monthly payment. The higher the monthly payment the less affordable the house becomes. The key issue though in house sales, IMHO, is the underwriting policy. During the bubble, underwriting policy deteriorated to the point where mortgages were written with no downpayment and no income verification. Effectively anyone was able to buy a house. Although artificially low interest rates helped, I believe it was pervasive poor underwriting that really fueled the bubble. Insititutions did not care whether or not the buyer was able to sustain the mortgage payments because the mortgages were securitized and sold to investors, not retained.

 

In a normal environment without the artificial socialist benefit of Fannie and Freddie, buyers would have to have 30 to 50% downpayment, the mortgages would be 10 to 15 yrs, the interest rates would be floating, and the institution would be required to retain the mortgage. Under these circumstances society would have minimum defaults and taxpayers would cease to be ATM machines. 

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  • 3 years later...

US rentals sliced and diced into new asset

 

 

http://www.ft.com/intl/cms/s/0/b4d3a65a-4731-11e3-b4d3-00144feabdc0.html?siteedition=intl#axzz2qIcZZaE0

 

 

Hank Rosely says it all happened very quickly.

 

The retired lawyer sold his Palm Beach house to Invitation Homes, the rental unit of private equity giant Blackstone, in August, in a transaction that closed within days.

 

Blackstone is one of a number of large institutional investors – from private equity firms to hedge funds – that have spent the five years since the worst of the financial crisis snapping up tens of thousands of residential properties on the cheap and converting them into rental homes.

 

Now they are beginning to package the rental proceeds from those homes into the kind of “sliced and diced” securitisations that proliferated before the bursting of the housing bubble in late 2007. This week Blackstone sold the first of these bonds – a $479m deal that bundled the cash flows from more than 3,000 single-family rental properties scattered across Arizona, California and Florida.

 

 

For some, the bonds represent the birth of an asset class, the future of the US housing market and a recovery in credit sectors that all but died during the financial crisis. For others, they look like a potential repeat of the securitisation machine that contributed to the last housing boom – complete with triple A credit ratings, high demand from yield-hungry investors and rapid expansion.

 

“Invitation Homes is buying so fast,” says Mr Rosely. “They truly are purchasing and handling enormous amounts of property, and the potential for explosion seems to be huge.”

 

The new bonds are known as “single-family rental” or “Reo-to-rental” securitisations. “Reo” is an industry term for foreclosed houses that have been repossessed by banks.

 

Firms including Blackstone, Colony Capital and a long list of real estate investment trusts have spent about $20bn acquiring 150,000 distressed properties, according to estimates from KbW.

 

Those purchases have helped push US house prices to their highest level since mid-2008, just before the worst of the crisis. These big institutional buyers are looking to finance and expand their purchases by securitising the rental proceeds.

 

“It’s basically a way to provide leverage for the Reo-to-rental business,” says Laurie Goodman, a prominent mortgage analyst and senior fellow at the Urban Institute. “To the extent that prices have gone up and you’re no longer able to generate a sufficient cash return to attract investors, it’s necessary to employ leverage.”

 

Analysts at Deutsche Bank, which helped structure the Blackstone deal, say the bonds also tap a growing trend in the US housing market – a shift away from home ownership. The rate of US home ownership has dropped from 70 per cent at the peak of the housing boom to 65 per cent, its lowest in 18 years.

 

“These securities could mark a revolution,” says Robert Shiller, the Nobel Prize-winning economist. “The securitisation of ownership of foreclosed homes . . . would really be a new thing.”

 

For months Blackstone’s bankers struggled to secure a credit rating that would make the deal palatable to investors. Rating agencies were initially wary of evaluating the deal, given their oft-highlighted pre-crisis failure to spot risks lurking in other mortgage-backed securities.

 

However, those concerns seemed to have eased in recent months as Blackstone tweaked the structure of its deal. Three rating agencies – Moody’s, Morningstar and Kroll – agreed to give the most senior slice of the deal a coveted “triple A rating”.

 

The top rating surprised many market participants, who had speculated that the security would be lucky to get a single A, if any rating at all.

 

 

 

Moody’s has said that one of the main factors in awarding the deal its highest possible rating is Blackstone’s ability to sell the properties if tenants stop paying rent.

 

Other rating agencies disagree with that reasoning.

 

Fitch warned that it might be difficult for issuers of the securitisations to liquidate their portfolios in a downturn. Others have voiced concern over the ability of financial firms to act as landlords for thousands of single-family rental properties.

 

“I’m excited about it, but I don’t know if it will work,” says Mr Shiller. “Apartments are efficiently managed. They’re all right there together and a super can watch everything that is going on. But if you are buying previously owned homes, there may be millions of different problems that can be very costly.”

 

Despite lingering questions over the risks of the bonds, demand at this week’s sale was strong.

 

Bankers sold the $279m triple A slice of the deal for 115 basis points over Libor, indicating that investors were eager to buy and that the bonds could provide a relatively efficient source of financing for Blackstone. “It means investors are clearly yield-starved,” says Ms Goodman.

 

The success of the sale means many more properties like Mr Rosely’s former Palm Beach home could soon be bundled up and sold to eager investors.

 

“Securitised loans backed by home rentals totalling in the billions is not out of the question by this time next year,” say the analysts at Deutsche. “Indeed, barring another recession, we find it hard to imagine how a relative flood of deals won’t happen in the next year or two.”

 

 

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  • 4 weeks later...

“ Would they pay more because interest rates are low? Nope.”

 

Unfortunately the answer to that may well be yes.

 

I deal with people building new homes on a regular basis and I have told this story here before, but it bares repeating.

 

I used to ask theses young couples how much their new house was going to cost and I was shocked that very few could tell me.

 

The conversations would go like this:

 

“So, how much is the house going to cost in total?”

 

The couple would look at one another with a blank look on their faces and the reply would be... “I don’t know, but our mortgage payments will be $1,200 a month.”

 

“Yes, but about how much will the house cost to build?”

 

“Well we never asked about that, but our mortgage payments will be $1,200 a month.”

 

“Look folks, if you pay $400K for the house today you will have always paid $400K for that house, but that $1,200 per month could well be a lot more than that in a few years”

 

“Haha....  well that better not happen!”

 

After running into that line of thought time after time, I don't bother asking anymore.

 

The only explanation I can come up with for this attitude is that these people have been used to leasing cars and don’t understand the huge difference between leasing a car and buying a house.

 

But as to the original question, unfortunately there are a lot of people out there who only look at the monthly payment and for an old dude like me who has paid as high as 17.5% for a mortgage I just shake my head at these 2.5% mortgages.

 

Mortgages have practically no room to drop, but the the potential rise is unlimited.

 

 

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“ Would they pay more because interest rates are low? Nope.”

 

Unfortunately the answer to that may well be yes.

 

I deal with people building new homes on a regular basis and I have told this story here before, but it bares repeating.

 

I used to ask theses young couples how much their new house was going to cost and I was shocked that very few could tell me.

 

The conversations would go like this:

 

“So, how much is the house going to cost in total?”

 

The couple would look at one another with a blank look on their faces and the reply would be... “I don’t know, but our mortgage payments will be $1,200 a month.”

 

“Yes, but about how much will the house cost to build?”

 

“Well we never asked about that, but our mortgage payments will be $1,200 a month.”

“Look folks, if you pay $400K for the house today you will have always paid $400K for that house, but that $1,200 per month could well be a lot more than that in a few years”

 

“Haha....  well that better not happen!”

 

 

 

After running into that line of thought time after time, I don't bother asking anymore.

 

The only explanation I can come up with for this attitude is that these people have been used to leasing cars and don’t understand the huge difference between leasing a car and buying a house.

 

But as to the original question, unfortunately there are a lot of people out there who only look at the monthly payment and for an old dude like me who has paid as high as 17.5% for a mortgage I just shake my head at these 2.5% mortgages.

 

Mortgages have practically no room to drop, but the the potential rise is unlimited.

 

 

“Look folks, if you pay $400K for the house today you will have always paid $400K for that house, but that $1,200 per month could well be a lot more than that in a few years”

 

Is it because they are using adjustable mortgage? If they locked a 30 year-fixed rate and they could afford the payments, what's the problem?

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“ Would they pay more because interest rates are low? Nope.”

 

Unfortunately the answer to that may well be yes.

 

I deal with people building new homes on a regular basis and I have told this story here before, but it bares repeating.

 

I used to ask theses young couples how much their new house was going to cost and I was shocked that very few could tell me.

 

The conversations would go like this:

 

“So, how much is the house going to cost in total?”

 

The couple would look at one another with a blank look on their faces and the reply would be... “I don’t know, but our mortgage payments will be $1,200 a month.”

 

“Yes, but about how much will the house cost to build?”

 

“Well we never asked about that, but our mortgage payments will be $1,200 a month.”

 

“Look folks, if you pay $400K for the house today you will have always paid $400K for that house, but that $1,200 per month could well be a lot more than that in a few years”

 

“Haha....  well that better not happen!”

 

After running into that line of thought time after time, I don't bother asking anymore.

 

The only explanation I can come up with for this attitude is that these people have been used to leasing cars and don’t understand the huge difference between leasing a car and buying a house.

 

But as to the original question, unfortunately there are a lot of people out there who only look at the monthly payment and for an old dude like me who has paid as high as 17.5% for a mortgage I just shake my head at these 2.5% mortgages.

 

Mortgages have practically no room to drop, but the the potential rise is unlimited.

 

 

This only matters with ARM type mortgages.  If all you know is that your P&I is $1200/month fixed for 30 years that is indeed enough information.  If the interest rates rise it won't effect you.  I've always used fixed rate mortgages to buy my homes. Interestingly, since I've never been in a home longer than 8 years,  I'd have been better off with a 10/1 ARM or even a 7/1 ARM every time.

 

 

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"In canada, the most common mortgage term is five year fixed which will likely be problematic for those that stretch themselves during this abnormal low rate period. Talk about asset liability term dismatch."

 

Also the mortgage rate goes up with the term which is another problem in itself because it is an incentive for those stretching their budget to opt for shorter term mortgages (say 1 or 2 years or a floating rate) to get the lower rates.

 

Longest amortization rate in Canada has been reduced (by law) to 25 years (40 years in 1998. Also, minimum down payment has been increased from 15% TO 20%, but there are tricks that are used to get around that.

 

One might think that, since the longer the term, the higher the rate, that this  could be a clue that interest rates may well rise.

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Something puzzles me about the US mortgage market, maybe just a silly question. The rates are quite low (3.5% for 15yr fixed). If it rises you got the rate locked in, but if it drops you can refinance to the lower rate. So who is taking the other side of the trade? Who is lending the money? Is the lender getting some kind of guarantee from the government thru FNMA? If so does the Canadian government also offer this help?

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Something puzzles me about the US mortgage market, maybe just a silly question. The rates are quite low (3.5% for 15yr fixed). If it rises you got the rate locked in, but if it drops you can refinance to the lower rate. So who is taking the other side of the trade? Who is lending the money? Is the lender getting some kind of guarantee from the government thru FNMA? If so does the Canadian government also offer this help?

 

assuming we are talking about agency mortgages.  my understanding is that most of the reason the rate is higher than an equivalent length treasury is due to pre-payment risk.  the agencies guarantee against default risk.

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So who is taking the other side of the trade? Who is lending the money?

Look at stocks like AGNC... that yield!  ;)

 

(AGNC may actually be one of the better managed companies in the business of buying mortgage-related securities on a leveraged basis.)

 

The FHA and the GSEs are also lenders.  Weirdly enough, during the subprime crisis, it was not the FHA / Fannie / Freddie who were making dumb loans.  It was the private sector originating all of the NINJA loans and the other nonsense loans.  Unfortunately, Fannie and Freddie bought lots of mortgage backed securities which owned those loans.

 

The ridiculously low downpayment on a FHA mortgage seems dumb but it might actually work.  (The effective downpayment used to be close to 0%.)  Things may not necessarily end badly for that type of lending.

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"Imagine just one buyer gets a special interest rate. Would that lucky buyer be willing to pay more than all other buyers for the same property? Nope."

 

The author is not making sense to me. If the local bank gave me a 30 year mortgage rate for 1% less than everyone else, you bet I would be willing to pay more than everyone else for the same house to win a bid.  I would be able to afford to pay more. It is the same effect if I get a raise, I would be able to afford and pay more. In aggregate a lot of people getting this lower rate financing, all else being equal, will increase home prices. Otherwise, why would the Fed be concerned with adjusting rates to control asset prices. Why did quantitive easing increase stock prices? If the fed lowered interest rates for only Oregon State, it would still increase all asset prices, just not as much as if he would for the whole country. If you were considering a company to invest in, wouldn't you pay a little more if their cost of financing is a little lower if their ROIC stayed the same?

 

I would say lower rate --> higher demand. But to make it more accurate: If rates are lower today than they are expected to be in the future --> more demand today. I could see a scenario in which rates move higher causing increased demand because of realization that they will rise in the near future and all time low rates will no longer be available.

 

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Something puzzles me about the US mortgage market, maybe just a silly question. The rates are quite low (3.5% for 15yr fixed). If it rises you got the rate locked in, but if it drops you can refinance to the lower rate. So who is taking the other side of the trade? Who is lending the money? Is the lender getting some kind of guarantee from the government thru FNMA? If so does the Canadian government also offer this help?

 

Randomep, good question. I bought my townhouse about 1.5 years ago (I'm in the US) and got a 30 year fixed for just 3.5%. I almost felt guilty except I remembered the unfair advantage that banks have. In 15 years when rates could be 8% someone on the other side will have lost money. I had the same question. Best answer I got was that banks think of it similar as a bond investor. As mortgage rates rise they will gradually bring their income higher with new loans. Plus they are borrowing short term from the fed at near zero o make that long term loan so they have a spread.

 

Also banks did not do too much lending the last Few years. They will also make more loans as rates rise and the lower rate loans will wash out in the average.

 

I think the one sided rate adjustment is more for the benefit of the banks. Otherwise the default rate would skyrocket coming down from peak inflation. In 1988, the holder of a fixed rate mortgage purchased in 1980 at peak inflation would likely default.

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I once read: if mortgage rates double, home prices decline by 15% within 2-3 years.

 

Let's say you made that statement two years ago.  Since then, mortgage rates on the 30 yr have climbed significantly (30%?) as did housing prices (20%?).

 

So from this point, for the statement to continue to hold true...  housing needs to drop 30% from here if mortgage rate climbs another 54%.

 

A 30% drop is almost as big as what happened in the Great Depression.

 

 

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I once read: if mortgage rates double, home prices decline by 15% within 2-3 years.

 

Let's say you made that statement two years ago.  Since then, mortgage rates on the 30 yr have climbed significantly (30%?) as did housing prices (20%?).

 

So from this point, for the statement to continue to hold true...  housing needs to drop 30% from here if mortgage rate climbs another 54%.

 

A 30% drop is almost as big as what happened in the Great Depression.

 

Like anything in economics you can make a statement like: "all else being equal if mortgage rates rise, housing prices will fall". But of course in the real world all else is never equal.

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