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In the US, mortgages and many long term loans are on a fixed rate schudule, in Canada and other countries, they are variable.
The obvious upside to fixed rates is that they lock consistent payments - debt expenses aren't going up for everyone who's already purchased, it's just gone up for those at the margin who are looking to purchase now. This helps as a stop gap of cascading effects from income / expense changes.
However, fixed rates also have some downsides: The most obvious one already happened, when rates are super low, there's a mad rush to purchase assets to lock in this good deal. In a variable rate enviornment, there wouldn't have been the same pressure to buy a house in 2021 because a good rate would likely only last a year or few but not the whole term.
The question now is what's going to happen over this period of rising rates? Variable rate enviornments are likely having higher inflation / expenses as everyone is footing the interest bill, but their markets could normal back out sooner. The fixed rate ones seem to be entering a freeze period that is pretty weird where no one is buying or selling or building.
During a long term falling rate enviornment, consumers are more boosted from fixed rates - they can refinance downward but are safe against upward rises. During a long term rising rate enviornment - well what happens there???
In the US, mortgages and many long term loans are on a fixed rate schudule, in Canada and other countries, they are variable.
The obvious upside to fixed rates is that they lock consistent payments - debt expenses aren't going up for everyone who's already purchased, it's just gone up for those at the margin who are looking to purchase now. This helps as a stop gap of cascading effects from income / expense changes.
However, fixed rates also have some downsides: The most obvious one already happened, when rates are super low, there's a mad rush to purchase assets to lock in this good deal. In a variable rate enviornment, there wouldn't have been the same pressure to buy a house in 2021 because a good rate would likely only last a year or few but not the whole term.
The question now is what's going to happen over this period of rising rates? Variable rate enviornments are likely having higher inflation / expenses as everyone is footing the interest bill, but their markets could normal back out sooner. The fixed rate ones seem to be entering a freeze period that is pretty weird where no one is buying or selling or building.
During a long term falling rate enviornment, consumers are more boosted from fixed rates - they can refinance downward but are safe against upward rises. During a long term rising rate enviornment - well what happens there???
People still are mobile. Maybe at a lower rate than it has been but few are going to stay put in their house for 20 years because rates went up. As with any shift there is an adjustment period. Think about inflation of the past 18 months. Some are going to sit around and wait for prices to come back down to "what they should be" but are they going to wait for 10 years for that? They'll just adjust or substitute and forget about their disgust with prices after some time.
A lot of countries have a blend of fixed and variable rates because fixed rate mortgage terms are short, like five to ten years. When that term expires, you need to get a new mortgage at the new rate.
I think thirty year fixed rate mortgages are great for ordinary people. Your downside of everyone rushing in when rates are low has some empirical gaps; rates weren't ultra low from 2003-2006, yet the frenzy was more pronounced. Also Canada has had even faster price appreciation than the US, despite having the mortgage structure in my first paragraph.
There are a lot of factors that can influence the housing market besides mortgage rates and terms. I think we're pretty lucky in the US to have thirty year term fixed rate mortgages with no prepayment penalty. That's a "heads I win, tails you lose" arrangement in favor of Joe Blow.
Local markets will respond differently of course, but generally speaking, prices will stabilize as demand cools off. The hope is that the housing supply will begin to normalize. I tend to think it will, but it may take a year or two. In some markets where home values actually drop from the peak, more homeowners may choose to walk away from their underwater mortgage.
The 10 year bond is at about 3.5%, which is pretty low in my opinion, but that seems to indicate that investors are betting on the Fed cutting rates soon. Buyers may opt for ARMs instead of locking in to higher fixed rates. I would not take that bet. I think higher rates are going to be around for a while.
Folks that are locked in to a low mortgage rate are in a pretty good position to park their excess cash in Treasuries and CDs. Why put extra cash towards the principal on 3% mortgage, when you can earn a low risk 4.5% to 5% yield from treasury bills?
What is the basis for thinking the "housing supply will begin to normalize" when, since 2008 the supply has been low? That could be resale or new construction. Generally, those who bought from 4Q2004 on (4 solid years before the real crash) couldn't sell without selling for less than they paid until 2013. That's a lot of people who didn't want to move. Now, since 2018, you've had 95% of those 6% mortgages refinanced down to below 3.5%. Then, despite the HBA and the Realtors yelling about "not enough new construction" it took until about 2021 for us to build as many houses as we were in 2006.
How motivated - or well-off - does a current homeowner need to be to take a doubling in payment for the 'same" home if they decide to move?
What is the basis for thinking the "housing supply will begin to normalize" when, since 2008 the supply has been low? That could be resale or new construction. Generally, those who bought from 4Q2004 on (4 solid years before the real crash) couldn't sell without selling for less than they paid until 2013. That's a lot of people who didn't want to move. Now, since 2018, you've had 95% of those 6% mortgages refinanced down to below 3.5%. Then, despite the HBA and the Realtors yelling about "not enough new construction" it took until about 2021 for us to build as many houses as we were in 2006.
How motivated - or well-off - does a current homeowner need to be to take a doubling in payment for the 'same" home if they decide to move?
Construction is going to tank again, already has in a lot of growth markets. I think normal markets just don't exist, its always boom or bust because the market is so sensitive to interest rates.
A lot of countries have a blend of fixed and variable rates because fixed rate mortgage terms are short, like five to ten years. When that term expires, you need to get a new mortgage at the new rate.
I think thirty year fixed rate mortgages are great for ordinary people. Your downside of everyone rushing in when rates are low has some empirical gaps; rates weren't ultra low from 2003-2006, yet the frenzy was more pronounced. Also Canada has had even faster price appreciation than the US, despite having the mortgage structure in my first paragraph.
There are a lot of factors that can influence the housing market besides mortgage rates and terms. I think we're pretty lucky in the US to have thirty year term fixed rate mortgages with no prepayment penalty. That's a "heads I win, tails you lose" arrangement in favor of Joe Blow.
But there is no free lunch though, things can't all be heads I win, tails you lose - someone foots the risk somewhere and that ends up back at the consumer of houses somehow.
My hypothesis is with the locking against upward rate movement but refinancing for downward means that the interest rate benefits or costs just get baked into the house price - and that leads to more wild gyrations in prices than if rates were variable.
So the benefit is consumers are protected against risk at purchase, but the downside is there's frequent periods of imbalance where it's not a good time to purchase. Those already in get sheltered, but those who aren't homeowners but desire to be have to ride the waves.
There's some economic fallout from this - it was pretty apparent during the pandemic spree where people were buying less optimal houses to try to get in and those that wanted to sell didn't because there was no other options to buy once they did sell. Having extended periods of bad times to purchase result in inefficiency. But on the other hand, having people exit their current home due to a rate increase they weren't expecting in a variable enviornment is inefficient as well.
Thought I'd resurrect this - the housing market seems to be entirely frozen at artificially high prices due to the fixed rate mortgage environment in the US. Nobody is budging, interest rates hikes aren't causing people to drop their home prices, they're just causing people to take the house off the market. That's not what is happening in variable rate countries, their homes have come back down in price as people would expect with rate increases.
We'll be in this state for another year at least. Will be interesting to see what happens after that. I'm concluding fixed rates are probably worse than variable, they just bake in all the interest rate costs into the price and lead to more frenzy / frozen markets like the 2020s have been. The subsidize existing homeowners at the expense of new incoming homeowners.
Last edited by Phil P; 08-17-2023 at 09:10 AM..
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