Posted on 08/13/2014 2:31:29 AM PDT by Sir Napsalot
How? ...If someone has a fixed rate mortgage, or if the home is paid off, why would an increase in interest rates cause a reduction in the equity of the house/property?
I wrote the same thing in the deep part of the housing crash a couple of years ago, and I got into the worst discussion I have ever gotten on FR, to the point where the other poster was almost threatening violence. People need to think outside the emotional attachment people have to their homes. The value of a house is not fully under the control of the owner. It is also a function of location, the economy, and interest rates, among other things. And finally, the true value of a house is not what you paid for it, it is what someone else will pay for it.
The first thing to understand is why house prices have appriciated in the last couple of decades. It is important to remember that this wasn't always true. For generations, houses were expenses, not investments. People sold them for less than they bought them. Then, in the early 80s, interest rates were at their peak, and started dropping.
People don't buy homes based upon the price of the house as much as they buy what they can afford in their monthly payment. If interest rates are lower, you can afford a higher monthly payment.
From an online payment calculator:
Principal: $100,000
Interest Rate: 9%
Maximum allowable payment: $1867
Home I can Afford: $231,993
-------------------------------------
Principal: $100,000
Interest Rate: 7%
Maximum allowable payment: $1867
Home I can Afford: $280,574
-------------------------------------
Principal: $100,000
Interest Rate: 4%
Maximum allowable payment: $1867
Home I can Afford: $390,994
As you can see, when interest rates are going down, I can afford a more expensive house. Since this applies to everyone, we end up in a bidding war, driving up the price of every house. However when interest rates go back up, the opposite happens. Read those calculations from bottom to top. Unless people's income gains at the same pace as interest rates rises, they won't be able to afford the same price house, and buy a lower cost house. Since it happens to everyone, the homeowners must cut their prices. This is what will drain the equity out of homes, whether or not the mortgage is paid.
You mentioned two solutions. There is a third and historically based solution since more or less the beginning of time. As a part of learning to be king, every prince took a course called inflation 101. It teaches how to get out of debt. Debt is just inflated away.
In days gone by, the coinage was debased in any one of several manners, all of which were taught in the course. Today, when there are no coins, there is a need to devalue the blip entries on electronic ledgers. Unfortunately since there is a plateaued economy, The policy for printing money and inducing price increases hasn’t worked.
Key to current price rises is wage inflation. In an economy where there is large or perhaps very large unemployment there can be little or no wage increases that induce price rises that increase wage s that increase prices.
The Democrats are working overtime to induce the wage inflation. Several governments have raised their local minimum wage. That is an unprecedented mind set. Cities don’t force wage increases.
“China’s been buying up our debt, meaning we “owe” them that money when they cash in a bond.”....
That is NOT how it works. The U.S. owes the holder of the bond the principle AT MATURITY. If it is a 30 year bond purchased 5 years ago we still have 25 years to pay the exact same interest payment and then the principle to the current holder, whoever that happens to be.
The value of that bond is inverse to interest rates; as rates go higher the value of the bond is less (except it rises to what will be paid back when it gets closer to maturity).
IF we were smart and had the money (two things I am not counting on, mind you) when our interest rates are higher in about 5 years we could start buying back these low interest bonds at pennies on the dollar.
I agree with that. The last resort is to simply hand out increasing amounts of printed money if employers won’t raise wages or if there is a dropping labor participation rate (as is currently the case here). This method worked out ok for Zimbabwe at the beginning.
Thanks for an informative reply. It explains how rising interest rates can reduce the potential profit or result in a net loss, if someone is wanting to sell the house.
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