The risks of buying with record low interest rates

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Submitted by carmelrenter on January 29, 2008 - 4:24pm

I was wondering what the risks are of buying with such low interest rates. It seems like in addition to the continuing decline of the housing market, at some point rates will go back up and drive prices down even further. Especially if the conforming loan limit is raised temporarily, wouldn't that cause an increase in prices during that period, only to drive prices back down again when the conforming loan limit resets?

Submitted by DWCAP on January 29, 2008 - 4:37pm.

You assume that the conforming loan limit would be allowed to go back down in the future. Politics and the NAR would never allow that to happen once the cat is outa the bag. Remember, this is the government that gave us a rebate on our taxes last year because they were still collecting a tax on telephones that was inacted to pay for WWI ( or WWII, I forget). Either way that was 60-80+ years of taxation. Temporary isnt really temporary, it just means that they will have to pass another "fix" next year. It lets a Pol tell you they are doing something when they really are not, and keeps the PAC and special interest lobby money rolling in. If you want an example, think the alternative minimum tax that is so loathed on this board. Every year it is indexed up alittle so the middle class doesn't revolt, but left open because if they fixed it, they would have to account for the Ten's of Billions of dollars that would be lost in tax revenue.

Submitted by blahblahblah on January 29, 2008 - 4:39pm.

This is a very interesting topic and I've been thinking about the same thing. If interest rates go back up, home prices will need to come down. However, interest rates won't go up unless we are in an inflationary environment. In an inflationary environment, salaries will increase too so that will put upward pressure again on home prices. It could very well be that the guy who buys today at a 20% nominal discount from the 2005 peak with a very low fixed interest rate could come out ahead of someone buying two years from now with a much higher rate, even though the nominal price might fall a bit between now and then.

I'm as much of a bear as anyone, but just such a scenario is worrying me a bit. I think the government is going to try to spend their way out of this mess with bailouts, new government programs and defense spending, etc... All of these will devalue the currency and would be inflationary. I hope I'm wrong...

Submitted by Aecetia on January 29, 2008 - 4:53pm.

FYI-

The tax was imposed in 1898 to help pay for the Spanish-American War. It was designed as a tax on wealthy Americans, back when phone service was considered a luxury.

Submitted by barnaby33 on January 29, 2008 - 5:05pm.

High interest rates do not mean high prices. High interest rates merely mean credit is scarce. Global wage arbitrage pretty much guarantees nobody is getting a big pay raise anytime soon. That was the 70's.

High interest rates are your friend if you are a first time buyer. It means lower prices, not higher. Especially when combined with stricter lending standards which are sure to accompany the higher interest rates. Coming soon to an unwilling lender (who's busy hoarding cash) near you!

Josh

Submitted by temeculaguy on January 29, 2008 - 5:18pm.

Aecetia, two points for you. I was about to reply when I saw your post about the Spanish American war. Good form but then I'd expect it from someone with your screen name (the goddess of fair trade and honest merchants).

Submitted by blahblahblah on January 29, 2008 - 5:25pm.

High interest rates do not mean high prices.

Certainly high interest rates will exert downward pressure on prices of those goods which are purchased on credit. However, interest rates are high in inflationary environments (like the US in the 70s). Although salaries lag inflation, they eventually catch up. I know this isn't a pleasant thought but it may occur, especially since the US is so dependent on capital inflow from foreign countries. If they want to keep selling t-bills, they won't be able to keep rates low forever.

Submitted by JWM in SD on January 29, 2008 - 5:31pm.

JWM in SD

"However, interest rates won't go up unless we are in an inflationary environment. In an inflationary environment, salaries will increase too so that will put upward pressure again on home prices."

Oh really??? Salaries will go up in an inflationary environment? How about an environment where your job is in constant danger of outsourcing and downsizing because the corporation cannot predict it's future costs adequately?

Repeat after me...there will be no wage inflation. Why? Because Bernanke and the Fed will not allow it to happen.

Get that out of your head right now because is completely wrong.

Submitted by blahblahblah on January 29, 2008 - 5:46pm.

Get that out of your head right now because is completely wrong.

I hope you're right. Still, there are two possible ways this can play out -- inflationary or deflationary. Right now it is headed towards the deflationary scenario with each fed rate cut. But an inflationary scenario is always possible. Remember that salaries increase only nominally in an inflationary environment, and that companies will be receiving inflated nominal values for their products as well. In a high-inflation environment, salaries and prices can be constant or even decreasing in real terms. Inflation is an easy and ever-popular way for governments to get rid of debt, by reducing the value of the currency the debt is denominated in. That's why I'm so suspicious that the guys running the show will choose that old favorite from the playbook...

Submitted by Eugene on January 29, 2008 - 5:56pm.

However, interest rates won't go up unless we are in an inflationary environment. In an inflationary environment, salaries will increase too so that will put upward pressure again on home prices.

For starters, 10-year is at 3.6% today even though we're not in a deflationary environment. (At least not in the strict sense of the word) Interest rates are so low because we have a bear market in stocks, resulting in flight to safety. Flight to safety temporarily overrides any deflationary/inflationary mechanisms that might be otherwise going on.

http://finance.yahoo.com/q/bc?t=6m&s=%5E...

Bear market will end eventually and at that point 10-year yields will likely go back into 4-5% land, if not higher.

Secondly, interest rates may go up if spread between 10-year and mortgage increases. This will happen if GSEs start experiencing financial problems.

Now, about an inflationary environment. Inflation results in higher long-term interest rates, higher wages, and depreciated currency. The effect on long-term interest rates and exchange rates is immediate (investors' expectations can change overnight). The effect on wages is drawn-out and delayed. In fact monetary expansion does NOT lead to wage inflation as long as there is substantial unemployment. Only when the unemployment is low, monetary expansion will start to translate into higher wages for everyone.

Submitted by DWCAP on January 29, 2008 - 6:13pm.

I stand corrected. WWI/II didnt sound right, but I couldnt put my finger on the right war. Should have done my HW, my old history professor prob just cryed alittle inside. Even so, my point still stands, if not is reinforced. In the US Gov. nothing is ever temporary unless policically unpopular. This is politically popular.

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