Feb092015
4% mortgage rates transfer wealth from Millennials to Boomers
Today’s 4% mortgage rates represent an artificial transfer of wealth from Generation X, Generation Y, and Millennials to Baby Boomers.
Even before the housing bubble created a great deal of false wealth, baby boomers were the recipients of an artificial boost in home prices due to 25 years of falling mortgage interest rates. At least 40% of the value of their homes was created totally by increased borrowing power of subsequent buyers.
Consider the following: the chart below shows the monthly cost of ownership from 1988 to 2015, and from 1989-1991 and again from 2011-2013, the monthly cost of ownership was approximately $1,850. Twenty-four years apart, the cost of ownership on a monthly basis was unchanged, yet house prices were nearly double. Why is that? Because in 1989, mortgage interest rates were north of 10%, and in 2012, they were 3.5%. Every penny of appreciation from 1989 to 2012 was a direct result of declining interest rates.
So what would have happened if interest rates hadn’t changed?
Let’s go back to the stable period from 1993 to 1999. The average monthly interest rate during that period was 7.63%. The average monthly cost of ownership was $1,538. That combination would finance a loan of $223,011. Add a 20% down payment, and the home price would be about $275,000 ($278,763 to be exact). Over the last 12 months, the median monthly cost of ownership in OC was $2,102. If you plug in that number in place of the $1,538 from 1993-1999, the resulting home price would be $380,089. The last reported median home price for OC was just over $560,000. House prices have been boosted about 40% due purely to the decline of interest rates from the mid 90s to today.[dfads params=’groups=4&limit=1&orderby=random’]
So who is the beneficiary of this artificial 40% boost in home prices? Baby Boomers.
Who is the loser who pays the price for the benefit enjoyed by Baby Boomers? Everyone who wants to buy a house over the next 20-30 years.
Today’s 4% mortgage rates represent an artificial transfer of wealth from Generation X, Generation Y, and Millennials to Baby Boomers. Since these mortgage rates represent the bottom of the interest rate cycle, it’s also the end of the road for the artificial appreciation based on falling mortgage rates. Future generations won’t be so blessed — and they know it.
Unfortunately for the Baby Boomers, the next generation isn’t excited about overpaying for real estate, so sales volumes are off, particularly among first-time homebuyers. Today’s buyers don’t make the direct connection between their home purchase and funding baby boomer’s retirements even though the connection is very real; today’s buyer’s simply don’t want to pay so much for houses with little future appreciation potential, particularly when they know house prices can also go the other way.
Further, since Baby Boomers were the first generation to fully embrace the dual-income household, one of the many reasons Millennials have not become a major force in the housing market is because they are delaying marriage, and many fear they may never embrace home ownership.
Though the transfer of wealth between generations is the primary plan to provide Baby Boomers with a comfortable retirement, so far the subsequent generations aren’t playing along.
Retiree housing wealth: Battered but still significant
Published: Feb 4, 2015, By Alicia H. Munnell
Given my enthusiasm for tapping home equity in retirement, either through buying a cheaper house or taking out a reverse mortgage, I thought it might be wise to take a renewed look at housing equity among those of retirement age. …
Reverse mortgages cause financial cancer and emotional pain; why anyone would be enthusiastic about that is difficult to understand. In my opinion, home ownership with no mortgage is the best retirement plan.
In 2013, 77% of households in their early 60s owned a house. The median house price was $185,000. But 63% of households in their early 60s continued to have a mortgage. Subtracting outstanding mortgage balances from the gross house price yields median home equity of $110,000, which accounts for more than 40% of the homeowners’ total wealth as conventionally measured. The fraction is lower if Social Security wealth and that from defined benefit plans are included in the wealth measure.Of course, the amount of home equity varies by income level. As shown in the table, the median amount of net home equity rises from $60,000 in the lowest income group to $302,000 in the highest. In contrast, the importance of home equity relative to total wealth declines as income increases.
Will the next generation buy their homes?
The importance of home equity over most of the income distribution shows that it could provide an important source of income in retirement. This income can be accessed by moving to a smaller house, which both substantially reduces property taxes and other expenses and provides a pile of assets that can generate returns.
The alternative for those who want to remain in their home is to take out a reverse mortgage. A reverse mortgage is a mortgage: a loan with the borrower’s home as collateral. But unlike a conventional mortgage, it is designed as a way for homeowners age 62 and over, with substantial home equity, to tap that equity as a source of funds to pay bills or health care expenses or to provide additional retirement income. (Full disclosure: I am an investor in Longbridge Financial, a company that provides reverse mortgages in a socially responsible fashion.)
Reverse mortgages in a socially responsible fashion? How does one inflict a financial cancer on someone in a socially responsible fashion?
Unlike with conventional mortgages, borrowers are not required to make monthly payments. The loan must be repaid only when the borrower moves or dies. This is the key advantage for retirees who need more income: So long as they live in their house, a reverse mortgage does not add a claim on the income they already have.
People with mortgages are eligible for a reverse mortgage, but must use those funds first to pay off their mortgage. Eliminating mortgage payments substantially reduces the demands on their monthly income.
Eliminating the mortgage payment is the best thing anyone can do for their retirement, and if this can’t be accomplished by paying off their current home, they should sell their current home and downsize into what they could own free-and-clear.
But the increase in households 60-65 with a mortgage on their home – from 53% in 1989 to 64% today – is a concerning trend.
Unlike the generations that preceded them, Baby Boomers were strongly encouraged to take out as much debt as humanly possible and be unconcerned about paying it back. It is troubling, but not surprising, they have far more debt than they should heading into retirement.
Paying the Baby Boomers Twice
Who will fund the retirements of Baby Boomers? Since housing was touted as the best retirement savings vehicle, and since 25 years of falling interest rates inflated the resale values of these properties, Baby Boomers fully expect to sell their homes for a large sum to provide for their retirements. The housing bust frighted many seniors as their property values crumbled, but the successful market manipulations since have reflated the bubble and given many seniors hope.
Perhaps some seniors will foolishly take out reverse mortgages to fund their retirement despite the fact that reverse mortgages are a really, really bad idea; however, most hope to sell their homes and enjoy a generational transfer of wealth from those working today to those who want to retire. Workers will already pay a great deal to Baby Boomers through Social Security, but in addition to this burden, workers must pay inflated house prices to buy a Baby Boomer out of their overpriced homes — assuming today’s workers don’t rebel and chose to rent instead.
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The low mortgage rates that are driving up the “value” of my paid-for residence mean almost zero interest is being paid on my savings, and that people dependent upon interest income, like retirees, are being driven into high-risk investments to realize a livable return from their accumulated wealth.
All in all, the baby boomers would be better off with less fake “wealth” in their houses, and more interest paid on their savings, while the younger generations would greatly benefit from lower house prices. What is the use of this so-called wealth if it means you are forced out of the house you struggled for decades to own, because you cannot pay the ever-rising taxes and because you are being inflated out of your earnings and savings, while your children are being extorted for outrageously inflated college tuition, and prices for their first homes… if they can afford to move out of the dump they’re sharing with 4 other people? And, of course, we would all be better off with lower house taxes.
You aptly described the problems created by the federal reserve’s ZIRP designed to save the banks. We must live with those unintended consequences because the powers-that-be decided saving the banks at any cost was preferable to nationalization and recapitalization.
FED Reserve is partly to blame for this but this is a global phenomenon this falling interest rates to boost investments and to fight deflation.
The baby boomers are only incidental beneficiaries if they sell. The gains in valuation are for the banks and wallstreet. Boomers that sell will have to find a lower cost place to move if that is even possible.
Spot-on!
That’s because when they sell, the hard-earned money boomers paid-in over time is paid back with money that has lost its value.
Fact: A loss of purchasing power is a loss, NOT a gain.
Yes, the policy was primarily designed to save the banks, but since the Baby Boomers owed the banks so much money, the two issues are inseparable. The real beneficiaries of the largess are the Boomers who were wise enough not to borrow themselves into oblivion. They get to enjoy the windfall from the policies designed to bail out the banks and their irresponsible brethren.
http://www.pieria.co.uk/articles/negative_interest_rates_are_here_to_stay
“If the elderly actually spent their savings, rather than living frugally to preserve capital, the release of that money into the economy would be a demand stimulus that would both raise inflation and arrest falling interest rates. And if those saving for retirement risked their money in young, growing enterprises rather than seeking low-risk passive investments in mature industries, property and government debt, it might dampen the cycle of asset price booms and busts and reverse the long-term trend of interest rates. But while governments buy votes by supporting unproductive investments and promising the elderly returns on their savings that they have no right to expect, and while we remain unable to find a more productive use for those savings than blowing up asset bubbles, interest rates will continue to fall.
Negative interest rates are here to stay.”
As Social Security payments to the elderly increase along with the population, the spending will also increase. Retirees won’t save their Social Security money, particularly if they have other assets.
I think the big problem is where retirees have money invested. As the article points out:
We need more balanced retirement savings incentives. By encouraging people to put all their money into housing, as a society we putting our resources into unproductive assets. If people were more strongly encouraged to invest in stocks, bonds, and other investments with more productive capacity, then the economy would experience greater long-term benefits.
The 4 shifts needed to boost new home sales
John Burns of John Burns Real Estate Consulting shares four philosophical shifts that must take place for new home sales to improve.
Burns puts the burden of changing not on the buyers, but on the builders and developers.
Burns says that developers need to change their business plans in the following ways to capture the market in its current conditions:
1. Less move-up housing
“Many of those born in the 1970s bought their first home 10+/- years ago and thus are far less likely to have sufficient equity to move,” Burns said. “They are also more likely to have gone through foreclosure, which has a marginally positive housing demand element to it, as some will return to homeownership soon. Not only are there fewer traditional move-up households, but a high percentage of them are unable to move.”
2. More luxury housing
“Luxury home buying typically occurs when buyers reach their years of peak earning and net worth,” Burns said. “The U.S. currently has more people in this group, aged 46-60, than ever before, and they have more income (two careers) and less expenses (fewer kids) than any generation before them. Compared to prior generations, this group is loaded.”
3. More retiree housing
“Eight million more people will turn 65 over the next 10 years than the last 10 years, and more of them than ever before plan to move, according to our Consumer Insights survey,” Burns said. “This creates opportunities in all regions and at all price points, as the demand drivers are no longer solely golf courses in sunny states. Proximity to kids and grandkids, as well as entertainment, and health and wellness are just a few of the main success drivers we see over and over.”
4. More entry-level housing, but not yet
“While entry-level buyers are financially challenged, the number of people is so large and the desire to own so high that many entry-level buyers will emerge over the next decade, especially if mortgage rates and down payment requirements stay low,” Burns said. “While most will buy resale homes for affordability reasons, a small percentage of a large number will still translate to strong new home demand.”
“desire to own is so high” LOL!
I think the desire is in fact high for entry level, most people I talk to would rather own than rent, but government / fed policy works directly against this.
I figure around 2-5% of those entry level buyers complaining “prices are too high” understand this, so on it goes.
I always get a good chuckle out of people (who make their money in RE) who portray “desire is so high” as if it’s going to equate to a purchase transaction.
Yep. The “desire is so high” is another version of “pent-up demand,” which is a fantasy or false projection of a realtor’s desires onto everyone else.
What does Barney Frank think of Dodd-Frank now?
HousingWire: What has been implemented in Dodd-Frank that is most critical in your view?
Barney Frank: I think the most important thing is moving derivatives out of shadows and into a situation where it is very unlikely to see a major respected institution like AIG about $170 billion in debt beyond what it could pay but not having any idea how much it actually owed. We moved to getting derivatives to a case of us saying this should be a market situation and it’s a good idea, but it should be an open situation in the open market.
Second, we increased capital in institutions to where they could pass every stress test.
And third, not related, is the establishment of the Consumer Financial Protection Bureau. It has not had the systemic problems or abuses that those in the House Republican side have said it would. It’s been very effective.
HW: Have regulators lost sight of the fact that Dodd-Frank was meant to end “too big to fail?”
Frank: I think they’ve done everything they could. There’s this stupid notion that a regulator is doing a favor by designating a financial institution as systemically important. We do recognize there are institutions that are institutionally too big to fail without doing something about their debts. But that’s different.
HW: How would you rate the CFPB?
Frank: I think they’ve done an excellent job, and they did not cause any of the problems that they were accused of, because no one can come up with an example of where they have. Then there’s this bizarre argument that there’s no oversight. (House Financial Services Committee Chairman Jeb) Hensarling has all these hearings to say that there’s no oversight.
And by that argument, there’s no oversight of the FDIC, the OCC or the Federal Reserve, because they’re not subject to appropriations either.
HW: Why were regulations on credit ratings agencies specifically omitted from Dodd-Frank?
Frank: We thought it was best to remove from statute books any regulations and requirement that an investor rely on ratings agencies. The best thing in my mind is for people to do their own due diligence. But if you want to (rely on ratings agencies), great, but it took away any federal imprimatur. They went for the standard of recklessness and not negligence that I would have wanted.
HW: Now that you’ve seen the bulk of Dodd-Frank implemented, where do you think you got it right, and is there anywhere you think you got it wrong?
Frank: I do believe securitization without risk retention is trouble. It substantially diminishes the incentive to be careful if no one has responsibility. At the last second (former Sen. Mary Landrieu, D-La.) introduced QRM and to my great dismay the loophole swallowed up the rule.
HW: What should be the future of Freddie Mac and Fannie Mae?
Frank: I think it would be better to replace them because they have basically become government agencies – between Fannie, Freddie, and the FHA, the government has too large a market share.
People on the House Republican side want to abolish them entirely. (I could see) chartering from the federal government a set of companies that would sell an interest rate hedge to lenders, not government-run but that would create a framework – but that’s too much government for House Republicans.
Mel Watt just did something we’ve been eager to do and that is to help build very good rental housing (through funding the Housing Trust Fund.)
HW: How do you walk the line between preventing discrimination and promoting affordable housing and homeownership on one hand, and not having lenders make risky loans on the other?
Frank: No regulator has said — it is not black people who don’t get a mortgage and white people that do – it’s that black people who are identically economically situated are getting worse deals – and the HMDA data shows this.
The other conflict people have greatly exaggerated is the importance of homeownership and the myth of homeownership benefits. Larry Summers would say no one has ever washed a rental car. But they do wash a leased car that they are going to be in for some time. I don’t want to tell lenders who is a good risk and a bad risk. I just want to say you make whatever judgment you want to about credit worthiness. But you have to retain some of the risk.
Homeownership is not a good way for poor people to save – I think there are other ways.
Job growth exceeds expectations
U.S. payrolls increased more than expected in January, signaling a build in economic momentum as 2015 got under way.
Employers nationwide added 257,000 new jobs last month, the Bureau of Labor Statistics (BLS) said Friday. Economists projected a payroll increase of 230,000.
Adding to January’s good news, payroll numbers for November and December were revised upward to 423,000 and 329,000, respectively, making November the best month for employment growth since May 2010.
The unemployment rate, which is measured from a separate household survey, ticked up slightly to 5.7 percent from December’s 5.6 percent, reflecting an increase in the number of Americans looking for work. After accounting for annual adjustments to population controls, BLS said the civilian labor force rose by 703,000 in January, bringing the labor force participation rate back up to a still-low 62.9 percent.
While decision makers at the Federal Reserve are likely to take notice of the faster rate of growth, recent statements from the central bank indicate they’re in no rush to move early on their plans to raise interest rates. In a statement in late January, the Federal Open Market Committee described the pace of job gains as “solid,” instead pointing to the slow rate of inflation as the factor holding them back.
Builders expect weak 2015
New-home sales disappointed in 2014 as closings fell to 352,830 after hitting 377,529 in 2013. If you include existing sales, it doesn’t get much better. In 2013, 5,186,382 homes sold. In 2014, that number fell to 4,681,495.
The primary culprit? The much-maligned first-time home buyer. The proportion of first-time buyers of new and existing homes dropped to 33 percent of the market in 2014—the lowest share since 1987—according to a recent National Association of Realtors (NAR) survey. While, by default, that meant the other categories—move-up and luxury—took up larger portions of the market, no segment really thrived.
What does that mean for the 2015 selling season? Not a lot, other than the fact that it won’t be too hard to improve over last year’s lackadaisical numbers. “I believe this selling season will be stronger than last year’s but not by a huge margin,” says Brad Hunter, chief economist and director of consulting for Metrostudy, the research arm of BUILDER’s parent company. “The primary key will be job growth and consumer confidence, which I expect to continue to pick up steam. The secondary key will be mortgage availability, which I think will improve slightly.”
Millennials not quite ready to start buying homes yet
Friday’s strong jobs report has several economists predicting a healthier future for the housing market. But it may be several years before the all-important Millennials are ready to start buying their first homes.
On Friday, the Bureau of Labor reported that hiring remained strong in January. Average hourly wages rose, too.
“The fact that jobs are stable means that potential home buyers feel more stable,” said Danielle Hale, director of housing statistics at the National Association of Realtors.
For several years now, that hasn’t been the case. Stagnant wages and unemployment among young people — the demographic that drives much of the housing demand — have kept many first time buyers out of the market.
But things are looking up, with employment among 25- to 34-year olds reaching its highest level since the end of 2008, the Bureau of Labor reported.
Young people with jobs and freshly increased wages won’t immediately come rushing into the housing market, however. They will have to save up for down payments and manage their student loan debt first, said Jed Kolko, chief economist at Trulia.
Another big hurdle: incomes.
“They need to see that growth in their income is substantial before they take on that financial obligation, which is the largest they’ll probably have in their life,” said Doug Duncan, chief economist at Fannie Mae.
Home prices have continued to rise faster than wages, and young adult employment remains below the levels that group enjoyed before the recession struck.
Duncan predicts that Millennials won’t be a primary driving force for the housing market for another four or five years.
Meanwhile, mortgage rates are expected to increase in 2015, and affordability will likely remain a challenge for many buyers.
“There are still obstacles to home ownership,” said Kolko. “There are many more jobs reports to get back to normal, but this is a step in the right direction.”
Something which is increasingly obvious in many areas of Orange County is if you just sold your house and invested the money you could cover rent for the same type of house in the same type of neighborhood and still have money left over. The paid off house saves you the “rent” but you are still responsible for taxes and repairs. Without the prospect for rapid price appreciation owning a home is a horrible decision at least where I live.
Interesting that when you take kool-aid out of the equation how differently people view real estate. Back in 2004-2007, nobody really cared about monthly costs because everyone was obsessed with making a fortune on appreciation. Now that it’s commonly believed house prices aren’t going to rise rapidly forever, people have no desire to overpay. As long as psychology doesn’t change, and as long as lenders don’t start underwriting more bad loans to enable foolish behavior, house prices are going to be flat, or at best rise with wage inflation, depending on what happens with mortgage rates.
Those are some big “ifs”. The cycle of loosening underwriting standards has really just gotten under way, after about 18 months of fits and starts following the Bernanke taper speech that caused rates to spike in mid-2013. Now that QM has been absorbed into lenders’ work flows, and Fannie / Freddie / FHA seem to be engaged in a race to the bottom, this is the first time that both government actions and lender desires have been on the same page. As lending standards continue to loosen and home prices reflect the additional buying power and larger pool of borrowers, you’ll see the psychology slowly start to change to Kool-Aid intoxication as the perception that RE is the easy path to wealth returns to the masses.
To me this is the key point. Since we are now qualifying people based on verifiable income, and since this qualifying income is applied only to 30-year amortizing mortgage standards, the masses don’t have additional buying power. If we qualify more people, we may force some downward substitution, but since loans are limited by real incomes and stable terms, I don’t see us inflating another bubble any time soon.
I’m assuming then, you take public transportation and do not own a car, as this is a horrible financial decision?
My point is, most Americans falsely think owning a home is a great “investment.” However, many bears this owning a home is a terrible “investment.” What both groups fail to acknowledge or understand, is that owning a home is a consumption item, like renting or buying a car, with an “investment” component.
I do own two cars but I buy them 3-5 years old so I get 70%+ of their useable life for half or less of their initial cost.
I am not a bear because I believe in the US economy and I am only speaking about Orange county as I understand the math changes depending on where you are thinking about buying.
In Orange county where I live most of these baby boomers should just liquidate their home and place the money in investments to live off for the rest of their lives. Instead they are running a negative monthly balance in carrying costs month after month in perpetuity.
I also despise the reverse mortages. How about grandma just rents out her house and lives in a nice senior apartment which the monthly rent would cover and then some. Does grandma still need 2500+ sq ft home for herself?
Your math is correct and for some that is a viable strategy, but you aren’t looking at the varying levels of risk. The lack of rent payment on a paid off house amounts to a nearly risk-free annuity and should be compared to investments with that same risk profile. Sure, you could probably double that return by playing the markets, but the risk is more than doubled to achieve those returns. A paid off house is often the best investment a retiree can make because there aren’t any other risk-free vehicles that can return as much. It’s better than an insurance annuity because you retain the equity and can pass it on to your kids.
A lot of the millennials are moving back in with mom and dad…not ready to buy homes. The study below may shed some insight on this…
Millennials are the best educated group of young adults in American history but are earning about $2,000 less per year than their parents did in 1980.
That seemingly contradictory equation is among the demographic data revealed in a recent report by the U.S. Census Bureau, “Young Adults Then and Now,” which focuses on the 18-34 age group. The analysis included data from the 1980, 1990 and 2000 censuses as well as the 2009-13 American Community Survey.
Will, I would seriously dispute the notion that the millennials are the “best educated” generation in our history.
Just because more went to “college”, after graduating high school with 7th grade reading skills on average, while previous generations graduated with reading and math skills equivalent to those of today’s typical non-STEM college grads?
The increased college attendance in modern times does not reflect a higher level of educational and intellectual attainment nearly so much as educational inflation, as our primary and secondary education has been substantially degraded over the past few decades, to the point where people are paying $15,000 a semester or more for “college” just to bring their skills to the level that would have been considered barely acceptable for someone graduating 8th grade before 1970.
Just another area where we are paying far more in return for almost nothing. Just ask any liberal arts major wtih $80,000 in college debt, who can’t divide a round number by ten without a calculator.
If Millenials truly are the best educated generation, then that should translate into being the highest paid generation once they reach peak earning years. That in turn should drive real estate prices higher.
The wealth is going from the middle and upper class to the govt. How many people do you know that are better now than 4 years ago !
Current doing a refi for 20 yr at 3.5%. My payment will soon be be $1,720. Very manageable. Currently renting out a room as well so the payment end up being only $1,200 plus taxes. With Prop 13 in place, the cost is pretty much fixed and I will be cruising for the next 20 years since I’m only 32. BTW thanks the FED for keeping rates low for so long. If you are a savers, in the last few years, you should be able to save enough for 20% down and buy at rental parity plus rates at record low. Yes your money earn next to nothing but than your house payment can be reasonable since rates are so low.
My financial life can only gets easier from here. This much I know. My future missus will surely appreciate this.
Where is the value. 60 year old construction, and in the Orange school dist, over half the the kids on reduced or free lunches. Kool aid can be a investment killer !
Who knows if this is the bottom of the mortgage rate cycle.
Why can’t mortgage rates go to 1-2% like Japan and even England?
In Denmark mortgage rates are NEGATIVE. They pay you take a loan.
Any rate increase is going to send the country into a recession.
[…] to the housing bust and rampant mortgage equity withdrawal, so they can’t make a move-up. Millennials don’t want to play the game, so they are choosing to rent instead leaving the entry-level market in shambles. Between the two, […]
[…] The powers-that-be catered to the Boomer’s wishes. If you think about it, 4% mortgage rates are a direct transfer of housing wealth from Millennials to Boomers. […]