Saturday, July 25, 2009

Interest Rates Matter

It was pointed out that rising interest rates reflect on home purchase prices. How much? Check these out. 5% is $5.36/$1,000 borrowed. At ~13% that's doubled. In other words what once cost $1,000 now needs to cost $500 to keep payments the same. Be sure to look at the total life payments figures as well.

And in case you thought 13% was too high:


1.44MB said...

The last time 20-odd percent was around it was entirely supply and demand driven - can't see that being the case again for a while.

Even with an inflationista outlook >15% seems high.

Tyrone said...

Some would say the reason why interest rates rose in the 1980's was to combat inflation, and during the 1970's inflation soared. Fed Chairman Volcker was forced to raise interest rates to in 1981 in order to fight that inflation. Federal deficits and quantitative easing have the potential to create high inflation. If this happens, we're heading back to 1981.

TJandTheBear said...

Damn, ain't I the troublemaker? ;-)

I don't believe the Fed will be raising rates, though; the market will take care of that for them.

p.s.: It won't take >15% rates to devastate housing; it's barely surviving at 5%.

w said...

It was just 1999 when new home buyers scraping together 5% for a down payment could barely qualify for a first and second mortgage and get a combined rate of about twice todays government subsidized rates.

Rates dropped 50% over 5 years and house prices went up 150-200%. Obviously, most of the bubble folks could not make the simple observance that interest rates were the only reason their house values were going up, so they continued to bid up the prices for anything on the market.

So we don't have to go back to 1981, only 1999.

Rob Dawg said...

Pick you number and figure the price. At 9% prices need to drop by a third. Another third.

Remember also that the return to the 20% down payment is going to affect how much people are willing to pay as opposed to able to pay.

w said...

Factor in the increases in health care costs and taxes and you shrink the possible cost of homes that much more.

Health insurance costs have about doubled in that time. Taxes were being cut during the bubble and are quite obviously going up on all fronts today.

Pleather Murse said...

Assumable rate mortgages on houses bought recently will make them more attractive in the future, however, given the historically low rates right now.

w said...

"The U.S. House of Representatives has already passed legislation that contains carbon tariffs. It would allow the United States to impose duties on imports of carbon-intensive goods such as steel, cement, paper and glass from countries that have not taken steps to reduce their own emissions."

I am starting to see what cap and trade really is. The government earns protection money for helping domestic companies keep out competition.

Rob, do you have any insights on this huge event? Are the Green's going to flip their lids when the program is finally looked at investigatively?

Lost Cause said...

The purpose of the Federal Reserve is to keep wages low. Inflation is a sort of code word.

The only tool that the Fed has is setting a few rates. The other half of rates is completely out of the Fed's control, and is controlled by the pricing of the bond market.

E said...


I agree on interest rates, but there is no return to 20% down payments.

FHA is the new subprime, giving out loans with 3.5% down. I don't think that will end as long as FrankenDodd are setting policy.

w said...

Stolen from the VCStar comments section

Posted by BubbaKidd on July 26, 2009 at 10:33 a.m. (Suggest removal)

People need to understand that the cost of these contracts will result in less police officers and firefighters on the job since more of out budget will be shifted toward funding inflated salaries and lavish pension benefits.

The current pay scales for SVPD are as follows:

Police Officer Trainee: 53,124
Police Officer: 60,647 - 83,660
Police Sergeant: 79,320 - 109,298
Police Lieutenant: 105,634 - 136,061
Police Captain: 120,838 - 155,825
Chief of Police: 142,000 - 186,740

If you work in the canine unit you get an extra $589 per month, detectives $100 per month, motors $100 per month, and if you are bilingual you get another $100 per month. The City also contributes $100 per month to your deferred compensation plan. If you have an Associates degree you get a 2.5% increase in salary, or if you have a Bachelors degree you get an additional 5%. SVPD officers work a 4/10 schedule, which means they work 10 hours per day four days per week. They get a 3% at 55 retirement, which provides a maximum 90% of final year salary after 30 years of service. The City pays the full cost of the pension, with no employee contribution required. Officers do not qualify for social security, but they also pay no social security taxes (saving $6,324 per year in Social Security taxes). After 25 years employees also get lifetime medical coverage for themselves and one dependent. Officers get 21 days of paid leave, which increases to 26 days after five years. Plus there are 11 paid holidays (paid out at 10 hours). The City contributes up to $1,526.66 per month for employee health insurance.

In fiscal year 2009 the police department had a personnel budget of $25,955,300, of which $14,115,500 was for regular salaries. The overtime budget is $2,899,000. If you divide the overtime budget by the regular salaries budget overtime represents an incremental cost equivalent to 20% of regular salaries. So we can assume that, on average, police personnel earn an additional 20% of their annual salaries in overtime. So you can take the salaries above and increase them by 20% to determine average compensation for Sergeant and below. Which means that a police sergeant with a bachelors degree who is at the maximum pay scale, earning 20% in additional overtime pay, should expect to earn around... $137,715!

Don't forget that the deluxe pension plan is also costing local taxpayers $4,457,500 per year, which represents the equivalent of 31.6% of salary. That means that it costs taxpayers $31,600 every year to just fund the pension plan for a police officer who has a base salary of $100,000 per year. Now with the steep losses in the stock market taxpayers should expect the cost of those pension benefits to rise dramatically over the next few years, and it is the taxpayers who are on the hook to come up with the money.

I love facts!

TJandTheBear said...


FHA isn't financing the high-end, and is another mortgage basket case on the verge of joining the GSEs.

I just don't see how the government can continue to finance it's own spending, let alone the entire US mortgage market.

TJandTheBear said...


Yeah, I'm still waiting for open warfare within the police unions when they realize the active duty cops are all being laid off to pay for the retirees.

E said...


FHA goes up to $697,000 in San Diego (varies by area). That's not the ultra-high end, but it's high enough to cover the vast majority of homes.

TJandTheBear said...


Yeah. Ridiculous isn't it? Just setting themselves up for (as they say) an EPIC FAIL.

TJandTheBear said...


Jim has a new video up, and in it he states he may owe you a cup of coffee. :-)

Anonymous said...


Back in the late 70s & early 80s had a lot going on. Nixon took us off the gold standard, the fed loosened in response to the oil embargo, causing price increases and speculation by the banks. Volker finally whacked the banks on the nose by raising short term rates, drying up their funding by killing the spread. This time we have a fed and treasury that has no intention of whacking the insolvent banks and the nose and QE will kill any notion of long term rates going up. Just my two cents.

Sun said...

Very interesting post, although I think you’ve hit on something much bigger here. The interest rate thing is like a window into a person’s decision making.

“Rates are low, it’s a great time to buy!”

Really? Interesting…with lower rates, that means I can have a bigger mortgage and make the SAME monthly payment!

Really? Interesting!!! With lower rates, that means the buyer can take out a bigger mortgage and make the SAME monthly payment. I’m just going to go ahead and add a zero at the end here…sweet!

Ok, so maybe the interest rate is a neutral factor(?).Uh Oh, except for one small thing. Buying prices are locked in (duh!); interest rates are fun and flexible!

Is this what separates winners and loosers? Bringing this up four years ago got me nothing but blank stares and skeptical looks.

Unknown said...

The U.S., like Casey Serin, will default on its outstanding debt in short order.

NoVa Sideliner said...

Ok, so maybe the interest rate is a neutral factor(?).Uh Oh, except for one small thing. Buying prices are locked in (duh!); interest rates are fun and flexible!

So true. Playing the interest rate/house-price game, the thing to do is to buy when interest rates are high. You lock in the price that's been pushed down because of affordability.

So long as you can suffer it out on ramen noodles till interest rates drop in a few years, you get a great deal when you refi down -- cheaper house, AND lower rate.

This is not at all the situation we are at today.

TJandTheBear said...


Yeah, a Realtor in an interview during the early stages of the bubble noted that (a) all the seller cares about is the price whereas (b) all the buyer cares about is the payment. That makes a monster cut in interest rates the perfect recipe for a housing bubble.

Sun said...

The U.S., like Casey Serin, will default on its outstanding debt in short order.

Not true at all. Congress has plans to curb spending over the next several decades. If you factor in those savings today we practically have a surplus! Now, stop focusing on trivial matters such as 10% unemployment and let's talk about something important. Healthcare reform!

TJandTheBear said...

CA BUDGET STUFF... apparently Steinberg, before boarding a plane to Hawaii, stated he expects to have to revisit the budget this year and fully intends to seek higher taxes at that time.

TJandTheBear said...


See my test scores? .25 to the right of you, otherwise dead on.

I'm going to have to stop frequenting here lest I be overwhelmed by confirmation bias.


Property Flopper said...

Did you hear that "thump"? I think that's the other shoe dropping. Large towers in SF are now "going back to the lender". A couple in just the last two weeks. Commercial real estate is about to seek the bottom.

Peripheral Visionary said...

On the interest rate front, the Fed can't be everywhere at once; and the more rates they try and hold down, the faster the foreign investors will panic and pull their dollar investments. Once the suppression of rates weakens, we'll see rates pick up very rapidly, something which is alreayd happening in low yield and spreading into high yield corporates.

On the commercial real estate front, starting to hear lots of rumblings. It's not sounding good, it may not be quite as big as the residential collapse, but given how fragile the system is at the moment, it could do major damage.

Lost Cause said...

"by killing the spread" Ahh...nothing like the spread between 1% and 5% compared to 18% and 22% -- is there? Both 4%, but the spread in percentages is 400% and the other is 18%. Banks can make a good profit now.

Other than that, Edgar, good point about the gold standard and Nixon in the 1970s. People tend to overlook that in the inflation picture back then.

Doug said...

OT, RD, but I came across an Oxnardian on an aviation board talking about housing and aircraft prices. This is from September 08. I think airplane prices have crashed back to 1995 levels now.

The (il)logic kind of makes me giggle.

My thinking is the same with the housing market. Houses will go down only so far before people will stop listing them. Especially the ones such as my self that are trying to sell to move and not because we can't keep up with the mortgage. At that certain point, you no longer list your property/plane because advertising becomes pointless. The problem with plane prices dropping I see is that the ones that go into bank repo may be like homes. They have to go low enough that the buyer can recoup costs that they incur to bring the plane up to current AD's and inspections, as well as maybe upgrade/fix other issues.

We are probably close to bottom now on plane prices as unlike homes not a lot of flip buying happened in the aircraft market. I'm thinking most of the plane sales are 1) no longer able to fly because of medical/age. 2) Unable to pay for the high fuel cost and rent.

The rising tide (credit bubble) lifted all boats.

ding g said...

We live in the Oak Park/Agoura and sold our condo in June of 06. Do you think it is time to get back in or does this area have alot to drop?

Rob Dawg said...

Long time readers know I'm getting anxious but I'm not ready to guess again until October. I'm confident that even if this is the time you won't miss much by waiting that long if only for seasonal reasons.

TJandTheBear said...

Anxious? Hmmmm...

I'm waiting for the next shoe to drop, and damned if it isn't going to drop quite a ways. Should see that happening this fall...

Entertained said...
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Bob said...
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Bob said...
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Lou Minatti said...

So I'm listening to a Hendrie podcast yesterday and it's a Vern Dozier bit from 2004. This time, Vern is a hyper-aggressive real estate agent who gets rude to "lookie loos" during open houses. Vern sells houses in Camarillo.