Nov162015
Could rising interest rates stimulate the economy?
Rising interest rates would put money into the hands of savers, particularly seniors, who will spend it on goods and services and stimulate economic growth.
Last week I wrote about interest rates. In the post Will Janet Yellen capitulate to greedy bankers and raise interest rates?, I lampooned a poorly reasoned heap of manure published by a Chase Bank lackey. The central thesis of the study was that rising interest rates could stimulate the economy.
Last Friday I met with a close friend who is a professional asset manager with 30+ years experience closely watching the economy and financial markets. I greatly value his opinion and the talks we have. He thought my post was too dismissive of the idea, and he challenged me to seriously consider the premise that rising interest rates could stimulate the economy.
In my post I noted that there was a good argument to be made that rising interest rates could stimulate the economy, but the Chase bank flunky failed to expound it. I plan to do that today.
How rising interest rates could stimulate the economy
The federal reserve manages interest rates on the basic premise that high interest rates deter borrowing and slow the economy while low interest rates encourage borrowing and speed the economy. Generally, this simple relationship holds true, but at the zero bound, strange things happen, and perhaps zero interest rates create an unusual stagnation that’s difficult to break out of.
Banks act as financial intermediaries. They make a profit on the spread between the rate at which they can loan money and the rate they must pay to obtain it. Banks can make money if rates are 2% or 12% as long as a margin exists between what money earns and what it costs.
Paul Krugman wrote back in February that Debt Is Money We Owe To Ourselves. He notes that one person’s debt is another person’s asset, so when a borrower makes a debt service payment, the interest expense for the borrower is interest income to the lender.
As long as interest rates are some number above zero, the flow of money from borrowers to lenders circulates throughout the economy, but when interest rates fall to zero, this flow of money stops — literally. The economy settles in to a stagnation equilibrium where borrowers don’t pay very much, but lenders — and in particular bank depositors — earn nothing at all.
When bank deposits earn nothing, the billions of dollars of risk-adverse savers like senior citizens earn nothing. When interest rates go up, the burden on borrowers increases, reducing their economic activity; however, the income to savers and bank depositors increases by equal measure, and many will spend it, particularly the seniors who need this money to make ends meet.
Thus, raising interest rates has the potential to stimulate consumer spending by putting money in the hands of bank depositors, many of who will withdraw with interest income and spend it.
Why haven’t rates gone up earlier?
If raising interest rates has the potential to stimulate the economy, why hasn’t the federal reserve raised rates earlier?
First, millions of borrowers became insolvent during the Great Recession, and it’s taken time for them to find work and improve the family balance sheet through retiring debt (mostly through bank write-downs). The job market has improved enough that fewer borrowers are insolvent, and more are capable of supporting higher debt service payments.
Rising rates will will be painful as the higher borrowing costs will push many marginal borrowers back into insolvency, but the slow financial death of those borrowers unable to get back on their feet over the last seven years will not endanger the financial system.
Over the last seven years, banks wrote down much of the bad debt on their balance sheets. While their books still show the borrowers owe them large sums, their loss mitigation practices have allowed them to write down the value of these assets on their own books, preserving their own solvency. In short, banks can take the hit now that they couldn’t take before.
Rising rates will also wreak havoc on the values of financial assets. The value of any financial asset is loosely tethered to the discounted value of future cash flows, and when the discount rate rises, values invariably fall.
The practice of corporations floating bonds with cheap debt to buy back stocks will stop, so stock prices will be volatile.
The value of long-term bonds will suffer from the higher discount rate and the more attractive yields on short-term debt, so the bond market will also be volatile.
Basically, those who hold financial assets will be in for a rough ride.
Asset values aren’t the economy
The inflation (and deflation) of numerous asset classes over the last several years is a direct response to cheap debt; however, these fluctuations have little to do with the functioning of the underlying economy.
In a normal economy, if investors drive up asset values of one sector of the economy, it spurs investment in property, plant, equipment, and labor to further exploit that resource. Over the last several years, that isn’t where this investment capital went. Instead, it merely flowed back into asset values and inflated them. If these asset values crash, it won’t have much of an influence on investment in goods and services actually producing something.
In short, even if the values of nearly everything declined, it won’t have a large impact on investments in productivity, so it won’t have much impact on the production of goods and services in the real economy.
What will happen to real estate?
I recently wrote that Rising mortgage rates will expose housing momentum myth because higher borrowing costs will cause sales volumes to crumble. Affordability will become a huge problem because the Housing inventory is abundant at prices buyers can’t afford. Back in January I stated that Affordability will be the major housing market issue of 2015. It was, and it will be an even larger issue in 2016.
What will a long-term rise in interest rates do to home prices? The main determinant of house prices is aggregate mortgage debt. It increased dramatically during the housing bubble, and it collapsed during the credit crunch. If mortgage balances fall due to higher borrowing costs, either house prices will fall, or sales volumes will dry up — or perhaps both with declining sales volumes first followed by falling house prices.
The feedback loop between real estate and the economy
I also stated my belief that housing will hold back the economy for the next decade. If the economy starts to heat up, the federal reserve will be under pressure to raise rates to combat inflation. If they then raise rates, it will cause housing to sputter or tank, and since homebuilding is a significant part of the economy, a decline in housing will drag down everything else and prompt the federal reserve to lower rates again.
I believe the economic drag caused by the impact higher interest rates will have on housing will be the biggest economic story of the next decade. Housing will be the laggard holding back the economy for the foreseeable future.
Of course, I expect realtors to spin it a bit differently….
Mortgage Rates Set to Rise, Adding Frenzy to Real Estate Market
Brian O’Connell, Nov 10, 2015
… “We should see continuing strong demand for housing in the months ahead if today’s strong jobs report reflects a true return back to a strong growth trend we’ve seen over the last few years,” says Jonathan Smoke, chief economist at Realtor.com. “The healthy strong employment results for the past two years created an uptick in household formation, which has driven increased demand for home purchases and rentals.”
“The jobs report will influence the long-term bond market, so mortgage rates will increase in response,” he adds. …
The economy is getting better. It’s my anecdotal observation that we are only now recovering from the 2008 debacle. It feels like we are back to an economy dominated by earned income rather than Ponzi debt.
I spent most of the last year searching for a commercial space. When I started in earnest in January, there was plenty of supply and not much activity. Over the course of 2015, I watched these vacant spaces rent up, and very little new supply came to market. Commercial inventories are tight again, and rents are rising.
Perhaps these future merchants are foolish optimists betting on a brighter future that won’t come to pass, but there are plenty of people willing to make this bet, and the money they spend on tenant improvements and inventory is stimulating the economy today.
“This development [higher rates] is not good news for people looking to take out mortgage debt in the near future,” Johnson says. “Once the Fed starts raising rates, interest rates throughout the economy, including mortgage rates, auto loan rates and other loan rates will trend upward. I believe that anyone thinking about refinancing a mortgage or buying a home and taking out an initial mortgage should not wait, as rates will rise.”
Like Smoke, Johnson also believes the jobs number will boost home sales. “Many potential homebuyers may see an opportunity to buy a home and take advantage of current low mortgage rates,” he adds.
… John Wake, the so-called geek-in-chief at Real Estate Decoded and a realtor with HomeSmart in Scottsdale, Ariz. “Many people expected the increase to be the first of many so they became even were more desperate to buy a house right away.”
The false urgency of realtor bullshit never goes away, does it?
Affordability products are not the answer
In the past when interest rates went up or prices got too high, lenders responded by offering affordability products. Those days are gone as these products were effectively banned by Dodd-Frank in order to prevent future housing bubbles.
Future house prices and sales volumes will be dictated by the course of interest rates. Based on what we’ve seen over the last 3 years, we can expect sales volumes to plummet when interest rates rise, and if they rise high enough, price pressure will mount. We won’t see a crash without must-sell inventory, but we may see air pockets where prices drift lower as discretionary sellers decide they want to get out.
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Developer unveils Sea Summit homes in San Clemente
After four decades of efforts to develop a 248-acre coastal palisade between Avenida Vista Hermosa and Avenida Pico in San Clemente, Taylor Morrison Homes is at last greeting potential buyers to its 309-home community, Sea Summit.
“We couldn’t ask for a better turnout and more positive feedback,” said Phil Bodem, Taylor Morrison’s Southern California division president, via email. “Over both Saturday and Sunday we were happy to host in excess of 3,500 guests.”
Most of the visitors came from Orange County, coastal Los Angeles County and northern San Diego County, Taylor Morrison said.
“We had numerous people making a buying decision,” Bodem reported. “We will work with them to help determine their next moves. Prior to the grand opening, we had sold 15 residences. The biggest ‘a-ha’ moment came from many visitors who told us they did not realize until setting foot at Sea Summit exactly how close we are to the Pacific Ocean.”
Before the opening, Taylor Morrison Homes gave the news media a preview of 12 model homes facing the sea. The company has 40 homes under construction to go with the 12 completed models.
“There is a lot of inventory that has come on the market in Orange County in the last three months, so there are a lot more choices,” Bodem told reporters. “There is nothing as unique and as special as what Sea Summit offers – the location, the views, the open space, the trails.”
Parents co-signing on a jumbo loan?
Stupid is as stupid does
Need help getting a mortgage for a million-dollar property?
Why not ask the parents?
Sounds crazy (probably because this really is) but some lenders are willing to lend jumbo mortgages, as long as parents co-sign.
However, the article states, the practice is not exactly widespread:
It’s one thing to ask mom and dad to co-sign a car loan. Getting them to co-sign a jumbo mortgage is a tougher sell all around.
The practice is rare, but a few lenders will allow parents to help their adult children qualify for jumbo mortgages, which exceed conforming-loan limits of $417,000 in most places and $625,500 in high-price areas such as San Francisco. A typical scenario: a first-time home buyer whose salary has a strong upward trajectory but who hasn’t been on the job long enough to meet income requirements to buy property in a pricey locale, such as New York, says Ray Rodriguez, regional mortgage sales manager for Cherry Hill, N.J.-based TD Bank, which lends in 15 East Coast states.
Let’s be clear, I’m not worried about the lender here, I’m worried about the parents.
Do they fully appreciate what they’re putting on the line?
Who raised these parents?
You have to love multi-generational dysfunction.
When did raising yourself up by your own bootstraps go to parents ensuring their children are wealthy no matter how lazy they are?
It’s a further sign of a dysfunctional system where this is something parents have to consider to help their children go so deeply into debt that they can’t afford it.
I am always a bit surprised when we receive questions about “title-only” spouses or worse, “non-title” borrowers.
New York Fed President Praises Progress of Housing Fundamentals
The weak advance report on Q3 GDP growth (1.5 percent, compared to 3.9 percent in Q2) and the weakness of the manufacturing sector have caused some concern among many that the U.S. economy is losing forward momentum, Dudley said.
But there are many positives to offset those negative economic metrics, one of which is housing, according to Dudley.
“In particular, domestic demand continues to grow at a solid pace as increases in consumer spending, housing and business fixed investment all contributed to the third quarter’s 2.9 percent annualized gain in real domestic final sales,” Dudley said. “A large decline in the pace of inventory accumulation was the main reason why real GDP growth faltered in the third quarter. Because the contribution to growth from inventory investment can be quite volatile on a quarter-to-quarter basis, the growth in real final sales probably provides a better sense of the state of economic activity than does the GDP figure.”
The fundamentals supporting domestic demand have been solid—consumer spending has increased supported by real income gains, and household net worth is rising—and housing fundamentals have been solid as well, according to Dudley.
“Housing prices are rising and the constraint on growth in residential investment now appears to be more on the supply side, as building contractors struggle to mobilize the resources needed to construct more homes,” Dudley said. “The National Association of Home Builders’ index rose in October to the highest level since late 2005. While the housing indicators will likely continue to be volatile on a month-to-month basis, I expect the gradual improvement in the housing sector to continue.”
Presidential Hopeful Ted Cruz Demands More Transparency from the Fed
Offers potential primary voters red meat
Just a few days after proposing to eliminate several government agencies, including HUD, Texas Senator and Republican presidential hopeful Ted Cruz agreed to cosponsor the latest Federal Reserve Act of 2015 (S. 2232), commonly known as the “Audit the Fed” bill introduced by Sen. Rand Paul (R-Kentucky).
Cruz and 20 of his colleagues signed on as cosponsors for Paul’s bill that would establish Congressional oversight and require a full audit of the Fed by the Government Accountability Office (GAO).
“The Federal Reserve needs to fully open its books so Congress and the American people can see what has been going on,” Cruz said. “This is a crucial first step to getting back to a more stable dollar and a healthy economy for the long term.”
Earlier this week in Tuesday’s nationally televised Republican presidential debate, Cruz proposed making budget cuts be eliminating government agencies he considers unnecessary, such as the Department of Education, the Department of Commerce, and HUD. He even proposed eliminating the IRS, calling it a “federal leviathan that has ruled Washington and crept into our lives.”
“We should shrink the size and power of the federal government by every and any means possible,” Cruz said. “What does that mean? That means eliminating unnecessary or unconstitutional agencies.”
“Right now, the Fed is adjusting monetary policy according to whims, getting it wrong over and over again, and causing booms and busts,” Cruz said. “If you look at the crash of 2008, the Fed’s policy destabilizing our money contributed powerfully both to the bubble and collapse. By auditing the Fed, the American people can fully understand the scope and consequences of the agency’s extraordinary monetary policy since 2008—and then know what reforms are needed to improve the Fed’s operations and accountability.”
Forecasters Predict GDP Growth Will Slow Down in 2016 and 2017
You can be certain these forecasts (guesses) will be wrong
The outlook for the annual growth rate of the U.S. gross domestic product (GDP) for the next two years looks somewhat softer compared to what it was three months ago, according to a survey of 45 forecasters conducted by the Philadelphia Fed.
The forecasters’ current estimates for average annual GDP growth are 2.6 percent for 2016 and 2.5 percent for 2017. Both of these figures represent downward revisions from their forecasts in August, when they predicted an annual growth rate of 2.8 percent for 2016 and 2.6 percent for 2017.
The prediction has been upwardly revised for 2018, however. Whereas the forecasters originally thought GDP growth for 2018 would be only 2.4 percent, they now believe it will be 2.8 percent. GDP growth has not averaged above 2.8 percent for an entire year since before the recession—in 2006, when it was 3.3 percent. In 2014, the GDP grew at an average annual rate of 2.4 percent.
“While it would seem good that the number of openings is increasing, demand for labor is rising, the fact that hiring and voluntary job separation remains low is an indication that there is a growing mismatch between the skills employers want and the skills employees have,” said Mark Fleming, Chief Economist at First American. “In other words, the labor supply isn’t aligning with labor demand. Anecdotal comments by employers that they can’t ‘find’ the right people for their jobs supports this. Interestingly this may be an indication of a tight labor market but not for the reasons we originally expected.”
“I also stated my belief that housing will hold back the economy for the next decade. If the economy starts to heat up, the federal reserve will be under pressure to raise rates to combat inflation. If they then raise rates, it will cause housing to sputter or tank, and since homebuilding is a significant part of the economy, a decline in housing will drag down everything else and prompt the federal reserve to lower rates again.”
The federal reserve has been raising rates for the last seven years – just really, really, slowly. Whether the economy sputters, tanks, or just expands less quickly, depends on the rate at which rates are raised. Same for housing prices.
If the economy starts to produce dramatic wage growth, which in turn drives up prices for goods and services, then wages will support higher rates. In this situation higher rates relieve excess inflationary pressure. A dovish fed will remain dovish until remaining dovish is hawkish. Are we there yet? Keeping rates too low for too long can cause an economy to sputter and/or tank just as raising rates too quickly.
One more wrinkle on this I hadn’t seriously considered: What happens if we get good wage growth without inflation?
Typically, wage growth serves to cause inflation because people take their wages and bid up the cost of goods and services. However, if higher wages get mopped up by higher borrowing costs to service existing debt, then the wage growth will not circulate in the economy and cause inflation. We could have wage growth without inflation if this were to come to pass, and it would be the best of both worlds, particularly for those with little or no debt.
Unlikely. Good wage growth will hit all households, but not all households have excessive debt. Those who have manageable debt will have even more manageable debt with rising wages. Those households will set the price level. As inflation rises, the Fed will raise short term rates. Raising short-term rates will encourage more lending. Higher wages will encourage more borrowing.
Monetary velocity will get up off the mat, and inflation will accelerate. Rates will rise further, and more capital will be pulled from the Federal Reserve. The Fed will further “tighten” by raising short-term rates, accelerating monetary velocity.
When the best form of risk-free liquid asset is no longer money, the Fed’s dilemma will switch from how to stimulate the economy to how to restrain it.
https://www.stlouisfed.org/On-The-Economy/2014/September/What-Does-Money-Velocity-Tell-Us-about-Low-Inflation-in-the-US
“Indeed, during the prerecession period, for every 1 percentage point decrease in 10-year Treasury note interest rates, the velocity of the monetary base decreased 0.17 points, based on a linear regression model of the velocity onto interest rates. Since 10-year interest rates declined by about 0.5 percentage points between 2008 and 2013, the velocity of the monetary base should have decreased by about 0.085 points. But the actual velocity has gone down by 5.85 points, 69 times larger than predicted. This happened because the nominal interest rate on short-term bonds has declined essentially to zero, and, in this case, the best form of risk-free liquid asset is no longer the short-term government bonds, but money.”
Don’t Fight the Fed: It’s Lower for Longer for Bond Yields
Bond investors aren’t fighting the Fed, but they aren’t panicking about higher interest rates, either.
Futures-market bets on rising U.S. interest rates have reached a six-month high, reflecting expectations that the Federal Reserve will raise short-term rates next month for the first time since 2006. The yield on the benchmark 10-year Treasury note has risen, too, trading Friday at 2.280%, near the highest level since July.
Yet, few analysts and traders expect rates to keep rising for long. Many investors say the yield on the 10-year note is likely to trade between 2.25% and 2.5% for the remainder of this year, reflecting uneven economic growth, soft inflation and strong demand for high-quality debt that has consistently foiled expectations for rising rates since the financial crisis.
“It is very hard for long-term Treasury yields to rise substantially in this environment,” said John Bellows, portfolio manager at Western Asset Management Co., which had $446.1 billion in assets under management at the end of September. “It could take a long time for long-term Treasury yields to normalize.”
Property in Sweden
Home is where the heartache is
House prices in Sweden continue to soar, to regulators’ despair
ASK a central banker what regulators should do when rock-bottom rates cause house prices to soar, and the reply will almost always be “macropru”. Raising rates to burst house-price bubbles is a bad idea, the logic runs, since the needs of the broader economy may not square with those of the property market. Instead, “macroprudential” measures, meaning restrictions on mortgage lending and borrowing, are seen as the answer. But this medicine is hard to administer, as Sweden’s housing market vividly illustrates.
Swedish house prices have doubled in the past decade, their rapid ascent only briefly interrupted by the financial crisis (see chart). So far this year they have risen by about 14%. Apartment prices have been even giddier, rising by more than 150% in ten years.
In part, this is a simple function of supply and demand. Stockholm is among Europe’s fastest-growing cities, with the recent influx of Middle Eastern refugees only adding to the demand for housing. Last month the country’s migration agency said it expected as many as 190,000 new arrivals by the end of the year, double its previous estimate. Sluggish and restrictive planning procedures limit supply: the current shortage of around 150,000 homes is expected to triple by 2025. A counterproductive rent-control regime has crimped the supply of flats in particular, and led to long waiting lists. Earlier this year an apartment in central Stockholm went to someone who had been in the queue since 1989.
Low interest rates have given Swedes the capacity to borrow more, pushing prices ever higher. The debt of the average household has reached 172% of income after tax. For people with mortgages in the big cities, the figure is nearly double that.
The most obvious way to calm things down is to raise rates. But the Riksbank, Sweden’s central bank, tried that in 2010-11, with disastrous results. Unemployment stopped falling and inflation soon withered, stirring fears of deflation. That prompted the Riksbank to reverse course in late 2011 and start cutting rates again. The benchmark has ended up lower than it was to begin with, at -0.35%, increasing the sums flooding into housing. “It’s like mopping whilst the tap is running at full flow,” complains one official.
To try to stanch the flow, the Finansinspektionen (FI), the country’s financial watchdog, has adopted curbs on both lending and borrowing. In 2013 it tightened capital requirements for mortgages, and since September it has required banks to hold an extra counter-cyclical capital buffer of 1% of all risk-weighted assets, to increase to 1.5% by next June. This will help if the property bubble bursts, but clearly has not been enough to stop it inflating.
Caps on how much individuals can borrow, in the form of maximum loan-to-value (LTV) and debt-to-income ratios, are another option. A recent IMF study found that in more than half of countries where this has been tried, credit growth and asset-price inflation fell. In 2010 the Riksbank embraced this policy, requiring a deposit of at least 15% for new mortgages.
The authorities have also tried to restrict the use of interest-only mortgages, which are common in Sweden. If borrowers use these to protect themselves from temporary financial problems while still paying down their debt, they can be helpful. But if they take out interest-only loans simply to borrow more, they exacerbate the bubble. Almost 40% of Swedish mortgages by value are not being paid down at all, and for many of the remainder the pace of repayments is slow. The FI has been trying to push banks and borrowers to agree voluntary repayment plans. It suggested that those with LTVs above 70% pay down at least 2% a year, and those with LTVs of 50-70% pay 1% a year. But in April a court quashed such efforts, arguing the FI had no authority to promote such plans.
In any case, the allure of cheap loans is so great that households in Sweden and beyond will find ways around the restrictions that remain in place. When the Slovakian government put limits on housing loans, banks boosted other forms of lending to bridge the gap. In Sweden, so-called “blanco-loans”, more expensive unsecured loans, can be used for that purpose. All told, credit is still growing and asset prices climbing, despite regulators’ efforts.
A better solution might be to eliminate the tax code’s various incentives for home ownership. Property taxes were abolished in Sweden in 2008; up to 30% of mortgage interest can be deducted from personal tax bills and a rebate of up to 50% can be claimed on home extensions and repairs. The Riksbank thinks that abolishing mortgage-interest relief alone could cut aggregate debt as a share of income by more than 50 percentage points over the next 50 years. Reducing the maximum LTV ratio to 80% would only trim debt-to-income ratios by five percentage points; the FI’s repayment scheme would cut them by 12.
The tax code is in the hands of politicians, as are the planning and rent-control regimes that impede the construction of new homes. An independent commission last year recommended urgent reforms to all three, but has been ignored. Politicians at least seem to be warming to the idea of cutting mortgage-interest relief, partly because they are looking for money to pay for the influx of refugees. But for the most part, measures to slow the property boom seem politically unpalatable. “People feel rich today thanks to these crazy prices,” says one member of parliament. “Nobody wants to be the one who breaks the spell.”
Politicians and regulators also know that any measure that obliges Swedes to spend more of their income on deposits or mortgage payments would be a drag on consumption, and thus a blow to an already fragile economy. “Ideally, I’d like to have something in my toolkit with which I could influence the housing market and nothing else,” says Henrik Braconier of the FI, “but up to now I have not found it.”
http://www.economist.com/news/finance-and-economics/21677671-house-prices-sweden-continue-soar-regulators-despair-home-where
This will be their downfall. This is the exact same problem we had, and it took a painful price crash to put the regulations in place to prevent its recurrence. Based on the pushback these measures endure today, only a coming price crash will shake them out of their complacency to do what must be done.
Opinion: Here’s the big problem with low interest rates
Low rates have created problems for savers and retirees around the world. Pension funds are in trouble with rising levels of unfunded liabilities. Debt levels continue to rise from unsustainable to even more unsustainable. Low rates have distorted financial markets and created asset price bubbles in shares, property, and other investments.
In Japan, for example, interest rates have been around zero for almost a decade. The Bank of Japan has undertaken nine rounds of QE. The central bank’s balance sheet is approaching 70% of GDP. It owns a significant proportion of the outstanding stock of government bonds and equities. But the policies have not restored growth.
The effect of further rate cuts is also diminished by continuing trade and currency wars. Each individual cut is increasingly offset by competing reductions elsewhere in the world. Despite denials by policy makers, countries are using monetary policy to devalue currencies to gain competitiveness and capture a greater share of global demand. Individual nation’s actions are now redundant in a nugatory race to the bottom in interest rates and currency values.
Maintaining interest rates at low “emergency” levels for an extended period also makes it increasingly difficult to increase them to more normal levels. Increase in debt levels, made possible by lower rates, means the financial impact of higher rates is attenuated.
Low rates and QE have also reduced the political appetite for needed policy changes. Lower interest costs have sapped the willingness for fiscal reforms, debt reduction, and structural reforms.
Asset markets, especially equities, have rallied repeatedly on the continuation of low rates. But low rates reflect slower economic activity and economic weakness, rather than strength. This means, at some stage, a dramatic reassessment of asset prices is now inevitable, either as result of higher or lower rates.
The Case for Buying a Home You Can’t Afford
This is the same reasoning that fueled the housing bubble
Here’s a happy reminder if you’re someone who finds escape by perusing real estate listings for unobtainable homes: A mortgage that strains your budget now will be a lighter burden a few years, and a couple of job promotions, down the line.
Young professionals willing to stretch their budgets now should consider Boston, Seattle, and Washington, D.C., among other cities, according to a new report from Trulia. In New Haven, Conn., the typical millennial (defined by Trulia as an adult between ages 25 and 34) can expect to spend 37 percent of her income on housing in the first year of her mortgage. Three years later, though, the same homebuyer’s monthly payments will fall below 31 percent of her income, according to Trulia’s estimates. By the last year of her 30-year mortgage, she’ll be spending 11 percent of her income on housing.
“There’s a sweet spot of metros where a mortgage looks obtainable but unaffordable, but where it doesn’t take long to become affordable,” said Ralph McLaughlin, a housing economist at Trulia.
[At least the reporter hasn’t completely lost perspective…]
Here are some other caveats: It wasn’t very long ago that U.S. homebuyers helped wreck the world economy by stretching their budgets to buy homes they couldn’t afford. Don’t do that.
[The two pieces of advice are mutually exclusive]
The author calls a mortgage which takes 37% of your income as unaffordable which it is not unless you have a bunch of other debt.
37% of gross income is still a big chunk, but arguably affordable. Dodd-Frank sets the maximum value at 43%, but I think that’s being overly generous to the banks. Remember, this is gross pay, not take-home.
I wrote a post some time ago about how the 43% DTI cap favors those with little or no debt because they could take on mortgage obligations above the typical 31% front-end ratio for housing:
http://ochousingnews.g.corvida.com/the-43-dti-cap-strongly-favors-those-with-no-consumer-debt/
FRBSF Economic Letter: What’s Different about the Latest Housing Boom?
http://www.frbsf.org/economic-research/publications/economic-letter/2015/november/what-is-different-about-latest-housing-boom-mortgage-debt-ratio/
Thanks, I may use that in a post. It makes the same case I have. The mortgage terms are stable. And the recent low mortgage rates made bubble-era prices affordable. Also, rising rents now justify the cost of ownership.
[…] I also noted that some economic models theorize that a small increase in interest rates could stimulate the economy. […]