I’ve diagnosed America once before with a mental health issue I call "housing-crisis post-traumatic stress disorder." But today, I’d like to cover another: interest-rate fixation.
Rates are low — really, really low. And artificially so, as time goes on, the government is slowly allowing some of the programs they imposed to keep rates low — to encourage buying and a housing recovery — to expire.
But it seems that the lower rates go, the lower we want them to be. My dad reminds me that in the early 1980s, rates ran as high as 15 percent, and people still bought and sold homes. Yet, after last year’s 4 percent rates, buyers being quoted 5 percent are turning their noses up at it, considering whether they ought not just take an adjustable-rate mortgage (ARM) at 3.5 percent instead.
For years, I’ve advised people to stop this fixation. In the middle of a sale transaction or a refinance, it can be paralyzing as people wait to lock rates to see if they go down even a smidgen the next day.
And once they lock — sometimes even for years after they buy — it can take over a homeowner’s psyche, as they watch anxiously for rates to decline, so they can soak in the misery of the illusionary dollars they might have saved had they lived, bought or refinanced in a scenario (a few days, months, weeks, years later) that can be described only as hypothetical. Sheer fiction.
And if they happen to have an ARM, the fixation is out of necessity — sort of a vigilant stop-loss against their own mortgage payment going higher than they can afford. These ARM borrowers keep their financial fingers crossed indefinitely, some playing that "When Should I Lock?" game for years on end as they wait for the low-interest jig to be up enough to warrant refinancing into a fixed-rate mortgage.
It’s as though we play this game of "How Low Will They Go?" But that fails to account for some essential truths about interest rates and the real estate and economic markets. While it is true that lower interest renders homes and mortgages more affordable, it is also true that the lower interest goes, the lower the tax advantage of homeownership.
While it’s highly improbable that mortgage rates will go lower than they are, it is possible. Virtually all American ARMs in America are set up to add some profit margin to the interest-rate index that serves as the basis for the loan’s rate.
So, if the Fed were to set rates at zero — highly unlikely, especially as the temporary nature of the debt ceiling raise threatens to send rates upward, but possible, hypothetically — most ARMs would come in at 1 or 2 percent interest.
But it takes only a quick historical look across the pond to see that the reality of a zero- or even negative-interest-rate situation would simply not be the fantastical utopia of money-saving we like to believe it would be.
In 2009, The Telegraph reported that the Bank of England’s interest-rate cuts threatened to send ARMs (which they call "tracker loans") into zero- or negative-interest-rate territory, creating a situation in which borrowers with then-popular interest-only ARMs would actually pay no mortgage payment or, even more bizarre, be paid by the bank every month.
Clearly, these loans must not have the common margin feature of American home loans, nor do those U.K. lenders, apparently, have the same sort of worst-case scenario-obsessed legal teams as American lenders do, who have written mortgage docs to ensure that some payment will always be due from borrower to lender — never in reverse.
Frankly, in the event that U.S. mortgages had rates as low as they could possibly go, down to 1 percent interest or thereabouts, U.S. banks would very likely do one of two things:
- Jack up the fees and/or margins on new loans, in a best-case scenario — meaning that consumers wouldn’t realize the savings; or worst case, they would
- Stop issuing home loans, which would wreak havoc on the housing market — stopping the relatively paltry numbers of buyers that are out there from being able to buy, and stopping existing homeowners from being able to refinance.
There are too many other ways banks can make money, and mortgages are now seen as a much more risky line of business than they used to be — so the risk-reward calculus for banks when mortgage rates are zero or negative would point against issuing those loans. The banks that did decide to stay in the business would have the freedom to charge high margins, again eliminating any savings to consumers.
This is no idle threat, either; just a few months ago, we saw a niche example of this actually happen, when Bank of America and Wells Fargo withdrew entirely from the reverse mortgage market, deeming it excessively risky vis-à-vis the businesses’ profit potential.
Further, at zero or 1 percent interest, there would be virtually no tax advantage to homeownership, as the mortgage interest deduction would be shrunk proportionally to the interest itself (although property taxes would remain deductible). That means homeownership would present much less financial advantage compared to renting, further diminishing the numbers of would-be buyers and, as a result, the value of homes.
So, next time you fantasize about how low interest could go, inject that fantasy with a couple of doses of reality, first understanding that today’s rates are actually very low, and then, realizing that if they went much lower, some highly undesirable things would happen in the market.
If you’re in the market for a mortgage right now, thank your lucky stars that it’s not 1982 and use these reality checks to cure your interest-rate fixation.