Ignore all the affordability nonsense. That just tells you interest rates are low.The price you pay for a home is far more important than the prevailing mortgage interest rate, yet Realtors would love for you to believe the opposite. In general, low interest rates simply mean there is low expected inflation. (Financial institutions aren't going to lend at 5% annual interest if they expect money to lose purchasing power at 7% annually.)
Imagine buying a $100,000 house under two different scenarios. In the first scenario, you pay 15% interest when inflation will be 12% annually during the duration of the mortgage. Your real interest rate will be 3% (because 15% - 12% = 3%). Sure, the nominal interest rate is high, but your house will also gain value at 12% per year. By the time you pay off your 30-year mortgage, the house will be worth $3 million.
In the second scenario, you pay 5% interest when inflation will be 2% annually during the duration of the mortgage. Your real interest rate will again be 3% (because 5% - 2% = 3%). Sure, the nominal interest rate is low, but your house will only gain value at 2% per year. By the time you pay off your 30-year mortgage, the house will only be worth $181,000.
Right now the Realtors want you to believe that somehow the second scenario is better for buyers than the first, but it is not. What's worse is that the Realtors actually want you to think that in the second scenario you should be willing to pay substantially more for a home than you would in the first. That's salesmanship.
To paraphrase Warren Buffett, "The price you pay determines your (real) rate of return."
Posts
James you really need to get your terms correct. And Realtors ,at least in my market area, do not sell or even suggest mortgage rates, that is the buyer and lender's responsibility.
ReplyDeleteI detect a chronic lack of a girlfriend here.
ReplyDeleteTruth is realtors add little or no value other than completing paperwork.
ReplyDeleteIt is all caveat emptor.
That applies to the house pushed by the realtors and the loans pushed by the banks.
Smartmoney above is disingenuous: Realtors will always say that homes are affordable now because interest rates are low.
Remember, all other things being equal, if interest rates rise, the price of homes falls.
Sales heating up? Even in DC?
ReplyDeletehttp://washington.bizjournals.com/washington/stories/2009/04/06/story1.html?b=1238990400^1804685
Looks like a lot of BUYERS have given up and capitulated...
"Sales heating up? Even in DC?"
ReplyDeleteNo no no... listen: my cousin's friend was robbed in DC back in 1998 when he went there to buy drugs. Everyone knows that DC is occupied by a bunch of thugs and freaks.
Places like PWC, Howard County, Spotsylvania County, Anne Arundel County, etc. are where the civilized people live. I know this, because I live in PWC and I have family in each of the above counties.
Just watch: DC's values will plumment through the basement floor, while PWC's values will finally line up with my affordability threshold. I know this is a fact, because it is what works for me personaly.
APRIL 3, 2009, 7:24 A.M. ET
ReplyDeletewsj.com
LONDON (Dow Jones)--Crude oil futures traded higher in London Friday, gleaning support from stronger Dow Jones Industrial Average, which was headed for its best four-week gain since 1933.
"Stock futures (DJIA) have improved, (bringing) short-covering," said Olivier Jakob analyst at Petromatrix, adding that oil traders continue to take their lead from stocks. "Crude oil is (acting as) a financial, rather than a fundamental trade."
"The move higher earlier Friday was so rapid, some participants suggested it could in part also be to a big buyer moving in, possibly to hedge against inflation. "
...
Short covering can mean a new floor is being established in terms of pricing.
http://online.wsj.com/article/BT-CO-20090403-704408.html
I don't understand this. Why would anyone want to spend money to create a new 'reality' TV series in Washington DC, when EVERYONE knows that Manassass is SO much better than Washington?! Another sign of the Apolcolypse?
ReplyDeleteReality TV coming to District
April 3, 2009 - 6:06am
WASHINGTON - Would you want every minute of your life telecast for the world to see? A new reality TV series is coming to the nation's capital.
The entertainment production company responsible for popular reality shows, including MTV's "The Real World," "Keeping Up With the Kardashians" and "The Bad Girls Club" has placed an online ad looking for a production accountant.
The ad placed by Bunim/Murray Productions seeks an Experienced Assistant Production Accountant. While the advertisement doesn't specify the series to be produced, the ad says, "The assignment is expected to begin April 22nd for approximately 20 weeks."
The "Real World," originally broadcast in 1992, changes cities in each season. The current season -- the series 21st -- is set in Brooklyn. Each season focuses on seven strangers who audition to live together in a house for several months, with every moment captured by cameras. The show has never been set in Washington.
(Copyright 2009 by WTOP. All Rights Reserved.)
Another story from another major publication about the demise of suburbia. Remember, if the main stream media is talking about a 'new' trend, the trend is already well under-way.
ReplyDelete"The American suburb as we know it is dying. The implosion began with the housing bust, which started in and has hit hardest the once vibrant neighborhoods outside the urban core. Shopping malls and big-box retail stores, the commercial anchors of the suburbs, are going dark — an estimated 148,000 stores closed last year, the most since 2001. But the shift is deeper than the economic downturn. Thanks to changing demographics, including a steady decline in the percentage of households with kids and a growing preference for urban amenities among Americans young and old, the suburban dream of the big house with the big lawn is vanishing. "
http://www.time.com/time/specials/packages/article/0,28804,1884779_1884782_1884756,00.html
Here is the story in Time:
ReplyDeletehttp://tinyurl.com/b447yn
"Anon said...
ReplyDeleteRemember, if the main stream media is talking about a 'new' trend, the trend is already well under-way."
Couldnt agree more Anon. Those that sit around and wonder why Arlington, Alexandria & DC have NOT fallen like the rest of the region have no idea. Years from now, after all the bubble pricing is gone and these areas have NOT reverted to their long term trend line will they get it.
Of course, by then it will be to late. Only then will they realize that they were PRICED OUT FOREVER.
"Of course, by then it will be to late. Only then will they realize that they were PRICED OUT FOREVER."
ReplyDeletemeh, Im already priced out, cause I wouldn't pay the rates that the trash here goes for. DC is a dump. I'm going to work here 5-10 more years, collecting your tax dollars, and move back to NY where things are still expensive, but class and culture exist as well.
huh??
ReplyDeletebecause a home is worth 3million at the end of the scenario #1, is that supposed to tell me i have more wealth or better off than in scenario #2??.. just because 3million is larger than 181000?
not correct at all
at the end of 30 years you are in exactly the same situation and have the same wealth. because after 30 years of 12% inflation the dollar would depreciate like crazy.
here is an example, leave a dollar on a table for 30 years. after 30yrs of 12% inflation i might be able to buy one gumball after 30 years. after 30 years and 2% inflation i can buy 15 gumballs. So in scenario #1, i would need $15 to buy 15 gumballs compared to $1 in scenario #2. Effectly the difference in scenarios is $15 at the end of scenario 1 = $1 at the end of scenario #2.
btw, i am not a realter, i am in finance
meh, Im already priced out, cause I wouldn't pay the rates that the trash here goes for.
ReplyDeleteGet a job, slacker.
"Get a job, slacker."
ReplyDeleteYeah thats the problem with the prices here. If I just get a job, perhaps people will realize an 800 square foot home built in 1940 just isnt worth $400K.
moron.
lancesmartmoney said...
ReplyDelete"James you really need to get your terms correct. And Realtors, at least in my market area, do not sell or even suggest mortgage rates, that is the buyer and lender's responsibility."
I'm not referring to real estate agents in general. I'm referring to members of the National Association of Realtors, and their Housing Affordability Index in particular.
And, by the way, a mortgage rate is a type of interest rate. The most correct term would probably be "mortgage interest rate". It's the interest rate you pay on a mortgage.
Hey James - remember the other day when you said DC prices would continue to fall after the rest of the US? Im curious, have you been watching the cataclysm that is taking place with NOVA inventory
ReplyDeletehttp://www.recharts.com/nova/nova.html
Its declining as if spring didnt happen.
In fall of 2005, your co blogger david picked up on that tremendous spike and on this very blog wrote things like:
"ITS THE INVENTORY STUPID"
http://bubblemeter.blogspot.com/2005/11/its-inventory-stupid.html
AND
"Inventory is surging. The boom is over."
http://bubblemeter.blogspot.com/2005/12/washington-dc-metro-area-housing.html
OH HOW RIGHT HE WAS!!! 6-9 months later, that was it, the prices started dropping, the rest is history.
Soooo Anyhew - IM curious, since inventory nationally is near an all time peak, will we see a recovery BEFORE the rest of the US, or AFTER the rest of the US?
Feel free to give an answer citing anything and everything you think is relevant. Just remember - its the inventory stupid!!!
Yeah, we have about 5 million people in the metro area. We see horrific traffic congestion "inbound" in the mornings and "outbound" in the evenings.
ReplyDeleteWhere is everyone going? Oh, now I remember, they're going to work.
Work? Who cares about jobs, anyway? Oh wait, now I remember; having a job is pretty important.
So people deal with horrific, epic traffic congestion in order to have a job "in the core" and to have an 'affordable' home in the 'burbs. Oh wait, didn't I hear something about the decimation of housing values in the 'burbs?
And isn't the proper valuation of assets what we're really talking about, after all? So we're watching the 'correction' but it doesn't jibe with our lifestyles..... we don't want to be in the 'core' unless it is 40+ hours per week, with another 15+ hours per week commuting to/from the 'core'.
We sleep in the 'burbs and cut the grass on the weekends, so housing values MUST be higher there, especially since you can get so much square footage to sleep in!
Wow, the trolls have some sand in their panties.
ReplyDelete"Leroy said...
ReplyDeleteWow, the trolls have some sand in their panties."
Ahh Leroy glad to see you are back --- albeit posting anon.
"Oh, now I remember....Oh wait, now I remember....Oh wait, didn't I hear something"
ReplyDeleteWho cares what you remember or heard? Who are you? You think you are some kinda authority/guru/oracle? Get off your high horse and quit building and answering your own questions. Prices are still dropping no matter how ridiculous you make yourself sound buddy ;)
"you make yourself sound buddy ;)"
ReplyDeleteGay much?
Anonymous said...
ReplyDelete"huh??
because a home is worth 3million at the end of the scenario #1, is that supposed to tell me i have more wealth or better off than in scenario #2??.. just because 3million is larger than 181000?
not correct at all
at the end of 30 years you are in exactly the same situation and have the same wealth. because after 30 years of 12% inflation the dollar would depreciate like crazy.
here is an example, leave a dollar on a table for 30 years. after 30yrs of 12% inflation i might be able to buy one gumball after 30 years. after 30 years and 2% inflation i can buy 15 gumballs. So in scenario #1, i would need $15 to buy 15 gumballs compared to $1 in scenario #2. Effectly the difference in scenarios is $15 at the end of scenario 1 = $1 at the end of scenario #2.
btw, i am not a realter, i am in finance"
That's exactly my point. The Realtors want you to believe that scenario #2 is better than scenario #1, but it is not. They are equivalent.
You seem to think that I said that scenario #1 is better. I did not. Go back and read the post again. I said scenario #2 is not better than scenario #1.
I assumed that readers understand how inflation works and I assumed that they understand basic logic. Perhaps I was wrong on the second assumption.
your wording does not imply that was your intent:
ReplyDelete#1
"...the house will be worth $3 million."
vs #2
"...the house will only be worth $181,000."
or how about these lines:
#1
"...Sure, the nominal interest rate is high, but your house will also gain value at 12% per year"
vs #2
"...Sure, the nominal interest rate is low, but your house will only gain value at 2% per year"
when i read those lines, you are clearly making a point with the word "only", pointing to the lower home value of 181,000 vs the higher 3,000,000 value. And how one house will appreciate at 12% rate, while in the #2 it will ONLY be 2%.
Regarding the quote:
ReplyDelete"Ignore all the affordability nonsense. That just tells you interest rates are low."
Here's a problem with that statement:
All affordability percentages are from CAR:
In 1983, interest rates were 12.5%, affordability was 31%
In 1987, interest rates were about 9%, affordability was 32%.
In 1992, interest rates were about 8%, affordability was 33%.
In 2001, interest rates were about 6.75%, affordability was 32%.
If affordability reflects low interest rates, how do you explain having virtually the same affordability with a 12.5% interest and a 6.75% interest rate?
In 2006-2007, you had the lowest affordability ever at 12% with a 6% interest rate.
Now, in 2009, you have an all-time high of 54%affordability with a 5% interest rate.
If affordability reflects “low interest rates”, then how do you have a 12% affordability rate with an interest rate {6%} that was lower than in any of the years 1983, 1987, 1992, and 2001?
Affordability measures the percentage of households that can afford to buy the median priced home. It takes into account interest rates, earnings, and the median price.
High affordability doesn’t make people want real estate and low affordability doesn’t make them shy away from it.
What is important is the direction of affordability. If affordability is going up, it is usually an indication of a soft real estate market; as in 1983 and 1982.
When affordability is going down, it’s a sign of a real estate market that’s gaining strength, where people are making money. That’s what happened in 1987 and 2001. In both cases, affordability would continue to decline, mainly because of very strong price increases. The more real estate went up, the more people wanted in.
Now, with prices in California at 50% off their peak, and affordability at all time highs, people are hesitant to buy. That doesn’t make it a wise decision; just a common one.
People do buy on monthly payments and right now, the monthly payment is on sale.
"Sorry I first posted this in the wrong place}
Anonymous said...
ReplyDeletewhen i read those lines, you are clearly making a point with the word "only", pointing to the lower home value of 181,000 vs the higher 3,000,000 value. And how one house will appreciate at 12% rate, while in the #2 it will ONLY be 2%.
Wow, you guys are picky about every single word I use. Trust me dude, I understand how inflation works. I've got a whole bunch of graphs where I adjust housing values by inflation. Most of the readers of this blog also understand how inflation works. Most of the readers of this blog—especially the bubbleheads—are not fooled by money illusion. (I think several of the housing heads are, though.)
I used the word "only" as a relative term because it is a lower inflation rate, and thus a lower nominal appreciation rate.
In accusing me of believing that scenario #1 is better than scenario #2, you ignore my use of, and adjustment to, the Warren Buffett quote. Warren Buffett's original quote is "The price you pay determines your rate of return." By adding the word "real", I am placing both inflation scenarios on equal footing. It is the purchase price that determines your rate of return (and thus your final value), irrespective of the inflation rate.
You also ignore the history of this blog in which we, and the bubbleheads who write comments, have long argued that the purchase price is overwhelmingly the most important financial factor in the purchase decision.
I considered explicitly stating that the two scenarios were equivalent, but removed the sentence during editing because I was afraid readers would start pointing out the different ways that the two scenarios are not equal. (They are not equal. For example, in scenario #1, the inflation-adjusted payments are front-end loaded, while in scenario #2 they are back-end loaded.) I felt such a debate would end up distracting from the point of the post.
I strongly suggest you take a course in logic. Saying that B is not better than A is not the same as saying A is better than B.
bruce norris said...
ReplyDeleteRegarding the quote:
"Ignore all the affordability nonsense. That just tells you interest rates are low."
Here's a problem with that statement: ...
I think you are taking the quote a little bit too literally.
Do you really think it's nonsense that the affordability rate is at an all-time high?
ReplyDeleteIf you believe inflation is coming, why would you not tie up a 5% interest rate when future rates would be higher?
High interest rates can also be accompanied by ever higher prices; evidenced by 1974-1980.
It is a "calculated risk" to assume you will buy at an exact low. I buy a lot of properties and for me, this is about as good a buying opportunity as I've ever seen.
By the way, my posts are not intended to be antagonistic. I've just spent a lifetime trying to understand this stuff and enjoy comparing notes.
"If you believe inflation is coming, why would you not tie up a 5% interest rate when future rates would be higher?"
ReplyDeleteBecause the value of the house will drop 50% if the rates go higher. The only thing keeping this sinking ship afloat is the outrageous low rates.....which cant last much longer.
"James said...
ReplyDeleteWow, you guys are picky about every single word I use. "
Yes we are - like when you said DC area would bottom AFTER the rest of the nation when that is cleary wishful thinking...
Anonymous April 6, 9:37AM said...
ReplyDelete"Because the value of the house will drop 50% if the rates go higher. The only thing keeping this sinking ship afloat is the outrageous low rates.....which cant last much longer."
I am in agreement with you.
However (in classic diplomatic fence-straddler fashion), I have to say that Bruce Norris has a point as well, when he said…
“People do buy on monthly payments and right now, the monthly payment is on sale”.
There are some (many/the majority I would venture to say) who buy houses for payments, and not for overall costs. I’m not saying its right, or that is the smartest thing to do in the long-run, but it’s the truth.
Anonymous said...
ReplyDelete"There are some (many/the majority I would venture to say) who buy houses for payments, and not for overall costs. I’m not saying its right, or that is the smartest thing to do in the long-run, but it’s the truth."
This concept is basically hyperbolic discounting. People have an irrational preference for the short-term. That's why marketers love teaser rates.
Bruce Norris said...
"Do you really think it's nonsense that the affordability rate is at an all-time high?"
Yes, because I believe that the price of a home is much more important than the prevailing interest rate. If interest rates go down, you have the option of refinancing later, but you can never go back and renegotiate the purchase price. Inflation-adjusted home prices right now are high by historical standards.
Bruce Norris said...
"By the way, my posts are not intended to be antagonistic. I've just spent a lifetime trying to understand this stuff and enjoy comparing notes."
Don't worry, I don't think you're being antagonistic. The people who are antagonistic usually go by the handle "Anonymous" (although most Anonymouses—yes I invented a new word—are not antagonistic).
Bruce Norris said...
ReplyDelete"Do you really think it's nonsense that the affordability rate is at an all-time high?"
Let me clarify that I do think mortgage interest rates are important, but I think the affordability indexes published by NAR and NAHB give undue weight to the interest rate.
Also note:
ReplyDeleteAs interest rates fall apparent affordability of housing seems to increase in terms of lower interest payments at prevailing prices. This naturally increases demand and causes prices to rise over time so only the early buyers obtain a small advantage. However, In the end, increased demand leads to principle inflation and this wipes out any advantages. In fact falling interest rates drags down the buyer with compensatory increases in principle payments that, unlike interest cannot be reduced by throwing more money at the mortgage. For example, let's say, over a period of time, interest rates drop from 10% to 5% and demand pushes prices up 100%:
$100,000.00 at 10% interest = $10,000.00 in interest payments per year for ~ first five years but only $100,000.00 in principle.
$200,000.00 at 05% interest = $10,000.00 in interest payments per year for ~ first five years but now $200,000.00 in principle.
So, in each case just under $50,000.00 in interest are paid before significant principle reduction begins to occur. Although this represents 50% of the first amount of principle and only 25% of the second, the buyer is still faced with 100% more principle to pay for the same house. Therefore, unless income rises at the same rate - and it has not; on an inflation corrected basis it has probably not gone up at all - this means that it is twice as difficult to pay off principle even if more than the minimal monthly payment is made on the mortgage to reduce total interest payments. This leads to a longer time to payment of principle and forces higher overall interest payments on the buyer.
Conclusion: Halving interest to 5% actually costs the buyer more in both nominal and real terms. And if you add the costs of ownership including but not limited to, purchase costs, taxes, insurance, fixing intitial unrevealed defects in the house, routine maintenance, repairs, sales costs, and moving costs, the situation for home buyers is abysmal! Who ever called a house a good investment?
all realtor are crooks...check out this funny short video that tells why
ReplyDeletehttp://www.youtube.com/watch?v=fdCVHbeH6rM