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lombardo

Will an interest rate rise not result in the same mortgage costs?

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Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

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I've asked myself this one too.  I'm worried that I've waited all this time to simply pay the same monthly payments I could have paid before in order to get a mortgage that is a lesser overall sum at a higher rate of interest.

In a way I deliberately haven't worked out the answer.......just in case it's the one I don't want to hear.

 

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I saw an estimate today the average Canadian monthly payment would rise by CA$85 following their 0.25% rise.

If you bought a house at a higher fix without prices falling, you might end up paying more on your mortgage in the short-term compared with a period of historically low rates. The relevant question is how you expect rates to be over the mortgage lifetime.

6 hours ago, lombardo said:

Will an IR rise only help those with lots of cash  or a big deposit?

It'll help everyone because cheap credit and asset purchases is making price discovery across all classes impossible and valuations unsustainably high. The people who will lose are those who take a write-down on an exaggerated paper asset value and the over-leveraged.

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it can become more difficult 2 earn money as the inflation has a tendency 2 over take pay rises (making stop_the_craziness's point of same monthly payment because the earning take a dive and interest on the property makes higher costs) but the saver with a deposit in his account will see higher return as the sticker price on the property drops helping to hit an equilibrium between savings vs cost. 

this means if interest rises the sticker price drops getting closer 2 the deposit while like 4 like on the deposit would be higher costs but in actual fact you would be dropping down a much larger deposit creating a saving from the deposit inflation offsetting the high priced interest on the mortgage.

for something like this 2 actually happen though would require at least a half arsed middle finger 2 the eu cause we gona sink if we continue 2 try and deal with those psychopath mafia and an actual rise in interest be4 we starve and try and eat our worth jack shit £5ers

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6 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

Maybe. 

Two points,

First is that mathematically an interest rate of 1.54% on a property at £450k would need an interest rate over 7% for a purchase price of £250k

Second, If rates are high, they have the possibility of falling. If rates are low (as they are today) then they can stay there or increase. It is possible of course that Japan was a couple of decades into the future and has shown us what life will be like once a developed economy runs out of steam and credit. 

What would be useful is some clever econometric regression analysis to determine the impact a 1% rise in mortgage rate would have on the price of property. This would give us the sensitivity of prices to interest rates. There is something similar (though it's just a yield formula) that is used for bonds called the 'modifed duration'. This is easier since bonds are always redeemed at their par value and therefore a yield to maturity can be calculated. One could view property as some sort of perpetuity i guess where PV = rent/discount rate (could use mortgage rate). Therefore something renting out at £1,000/month is £12k per year and lets say they've a 25% deposit so borrowing at 1.1% then the value of that future income today is 12,000/0.011=1,090,909.

This would appear to be slightly ****** in terms of value since a flat in Reading for £400k would probably generate at least that. What we can do though is flex the numbers. 

Lets say teh rate increases by 1% to 2.1%

12000/0.021 = 571,428 a fall of 48%

assuming they went up again by 1%

387,096 a fall of 32%

to 4.1% gives 292,683 (incremental fall of 24%)

While there's much more to consider from the point of view of a revenue stream into perpetuity is would seem house prices are vulnerable to rate increases, and increasingly so the lower the current rate is. However, I guess one could also say that the revenue stream is what is left over after paying the mortgage and cycling that back through the formula to use the value of the net income. I don't have Excel on my home computer and have an early start tomorrow so that's it from me for now on this. 

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20 minutes ago, happyrichie said:

it can become more difficult 2 earn money as the inflation has a tendency 2 over take pay rises (making stop_the_craziness's point of same monthly payment because the earning take a dive and interest on the property makes higher costs) but the saver with a deposit in his account will see higher return as the sticker price on the property drops helping to hit an equilibrium between savings vs cost. 

this means if interest rises the sticker price drops getting closer 2 the deposit while like 4 like on the deposit would be higher costs but in actual fact you would be dropping down a much larger deposit creating a saving from the deposit inflation offsetting the high priced interest on the mortgage.

for something like this 2 actually happen though would require at least a half arsed middle finger 2 the eu cause we gona sink if we continue 2 try and deal with those psychopath mafia and an actual rise in interest be4 we starve and try and eat our worth jack shit £5ers

I've posted a link on this recently. Wages track inflation in the short to medium term.

I can't for the life of me follow the rest of your post. 

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7 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

I have covered this many months ago but will try to illustrate with another example again.  High IRs are good for house buyers.

For example, I earn £1000 pcm and can spend £500pcm max on mortgage interest. Maximum interest I can pay is 500 x 12 = £6000 pa.  

1% pa interest rates 

Maximum acceptable price for me (on no repayment mortgage) is 6000 / 0.01 = £600,000.

I decide to stretch and pay extra £100 pcm to repay the capital value.  Very approximately, the repayment term is 600,000 /100 /2 = 3000 months = 250 years

I decide to save on heating and eat roadkill to add another £200 to my repayments.  The repayment term becomes 600,000 / 300 / 2 = 1000 months = 83 years - I have been cold and eating roadkill all my life and I will still die without a house!

10% pa interest rates

Maximum acceptable price for me (on no repayment mortgage) is 6000 / 0.1 = £60,000.

I decide to stretch and pay extra £100 pcm to repay the capital value.  Very approximately, the repayment term is 60,000 /100 /2 = 300 months = 25 years

I decide to save on heating and eat roadkill to add another £200 to my repayments.  The repayment term becomes 60,000 / 300 / 2 = 100 months = 8.3 years - I will be debt free soon!

Edited by Bear Hug

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8 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

On day 1 of your mortgage yes, an efficient housing market will see to it that your morgage payments are just within affordability.

However high interest rates tend to be followed by inflation, if everything has doubled in price after 10 years, then your mortgage costs will have halved relative to your wages. Assuming that you pay at least the interest every year so the debt is not growing. This is where the idea of the housing ladder comes from - after a few years you can trade up to a bigger house still paying the same proportion of your salary.

Ultra Low interest rates create the opposite - a "housing ladder" where it will take you 100 years of saving to reach the next rung. A lot of house buyers are currently in a situation where the first house they buy is likely to be all they will ever be able to afford.

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14 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

The connection between interest rates and house prices is not a clean efficient correlation. Throw in wage rises, general inflation and  the 'non investment' demand for houses then it can be all over the place. 

Also if rates rise (and assuming the mortgage is not a 25 years fixed one) then the person who pays £600k for a house today worth £300k in a year or so has a double whammy. 

But I understand the question and I think the answer is that 'it depends'. Also in terms of buying it is really an assessment of just how overpriced you feel the market is today. Prime London is a crazy example of high prices (albeit some nice correction recently)....but in North East England the view may differ where house 'might' be a similar price to 2004.

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15 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

You've waited all this time and not saved enough cash to buy one for cash ?

You seemed to have missed the point of the crash.

:lol: :lol: :lol: :lol: 

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Lombardos logic is broadly right but the relevance of the moves in rates and prices over the mortgage/ownership period depend when you get on and off the ride and the descisions you make while onboard. 

For example when rates fell I remortgaged from 6% to 3% and had the choice of cutting my repayment amount or keeping it the same. I kept my mortgage repayments the same and halved the remaining term of my mortgage. 

At 41 I'm 3 years from clearing my mortgage and would love to upsize. I'm hoping for price falls to help me do that, having effectively 'banked' the value of a bog standard 3 bed ex council semi. Most of my relatives are in the opposite position...either having just remortgaged to the hilt in the last few months at the peak of the market , or sitting in a massive house with no kids talking about downsizing and releasing cash but never biting the bullet through fear of losing out because prices only ever seem to go up.

The recent MMR changes will have an effect also - if rates hit 7% as mentioned above then MMR stress testing for repayment would be conducted at around 12% which is close to the highest mortgage rates in my lifetime. I would imagine this would put a hard brake on price rises (except for cash, BTL and overseas investors...) Though i'm sure the BoE will find an excuse to slacken the MMR buffer rates at will to 'encourage' the market as they do with banks capital buffers for example.

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9 hours ago, adarmo said:

Maybe. 

Two points,

First is that mathematically an interest rate of 1.54% on a property at £450k would need an interest rate over 7% for a purchase price of £250k

Second, If rates are high, they have the possibility of falling. If rates are low (as they are today) then they can stay there or increase. It is possible of course that Japan was a couple of decades into the future and has shown us what life will be like once a developed economy runs out of steam and credit. 

What would be useful is some clever econometric regression analysis to determine the impact a 1% rise in mortgage rate would have on the price of property. This would give us the sensitivity of prices to interest rates. There is something similar (though it's just a yield formula) that is used for bonds called the 'modifed duration'. This is easier since bonds are always redeemed at their par value and therefore a yield to maturity can be calculated. One could view property as some sort of perpetuity i guess where PV = rent/discount rate (could use mortgage rate). Therefore something renting out at £1,000/month is £12k per year and lets say they've a 25% deposit so borrowing at 1.1% then the value of that future income today is 12,000/0.011=1,090,909.

This would appear to be slightly ****** in terms of value since a flat in Reading for £400k would probably generate at least that. What we can do though is flex the numbers. 

Lets say teh rate increases by 1% to 2.1%

12000/0.021 = 571,428 a fall of 48%

assuming they went up again by 1%

387,096 a fall of 32%

to 4.1% gives 292,683 (incremental fall of 24%)

While there's much more to consider from the point of view of a revenue stream into perpetuity is would seem house prices are vulnerable to rate increases, and increasingly so the lower the current rate is. However, I guess one could also say that the revenue stream is what is left over after paying the mortgage and cycling that back through the formula to use the value of the net income. I don't have Excel on my home computer and have an early start tomorrow so that's it from me for now on this. 

Very good post and I suspect you didn't have to take your socks off to use your toes for counting :P

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Fixed rates and teaser rates complicate any increase in the base rate.  Those on SVR and BoE trackers take the brunt.

What happens if rates raise is probably a slow burn.  Although in terms of borrowing people it seems are maxed out.

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29 minutes ago, btd1981 said:

Some interesting analysis above, but don't fantastic schemes like the Term Funding Scheme render this purely academic?

:lol: :lol: :lol: :lol: :lol: 

 

There's nothign academic about robbing people using money printing.  I will result in a very angry set of people who, if things go t*ts up, are capable of anything.

 

Edited by TheCountOfNowhere

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22 hours ago, lombardo said:

Prices may go down with an IR rise but wont people end up paying exactly the same if they get a mortgage? I.e. the banks will try to suck the same amount out of them?

Will an IR rise only help those with lots of cash  or a big deposit?

It's a genuine question because I know little about this.

 

What has allowed the cost of houses to reach batshit crazy levels is the fact that interests rates have been so low for so long, coupled with some quite lax lending practices.  So people borrow a lot, but low interest rates enable them to pay it back on a month to month basis.

Higher interest rates imply lower capital borrowing as people tend to look at their monthly repayments and will typically borrow to their perceived ability to repay every month.

This in turn implies that house prices are going to fall (because people can´t borrow as much).

In the event of such a deflating bubble, people are not going to take on the same monthly debt obligation to buy an asset that looks to be falling in price .. so further downward pressure on prices.

Also, with a likely accompanying recession, people aren´t going to want to take on as much debt, full stop - again downward pressure on prices.

So in the event of prices dropping, I expect to see new mortgages cost a bit less per month on average, even with higher interest rates.

 

For people who already have a high capital debt obligation (because they borrowed loads of money off the back of a runaway HPI bubble and low interest rates) ... well, they are screwed.  Their monthly mortgage payment is going to rocket once they come off a fixed rate deal.

 

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7 hours ago, btd1981 said:

Some interesting analysis above, but don't fantastic schemes like the Term Funding Scheme render this purely academic?

Theoretically, yes. But it's far from clear that the Scheme cash is actually making it into the economy proper (suspicion is that the banks are lending it to each other not their customers). Plus the TFS ends in February/March 2018. I think Carney will be very cautious about extending it when it's reviewed in August. The Bank won't want to risk exposing the pound to additional negative sentiment at this juncture.

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I got a bit lost with some of the answers, so apologies if this has been written already.

In short, a rise in interest rates will make mortgage payments more expensive. This will put people who are maxed out into distress, in extreme cases they will be forced to sell (giving up or even repossessed).

The increased costs will reduce the amount people can afford to borrow. This will give them less spending power, meaning new entrants to the market won't be able to pay as much for a house as they could before. When this happens to enough new entrants, and more houses start coming on the market due to distressed / forced sellers, something has to give. Those who want to sell eventually start lowering their sale prices into the range of the reduced amount the new entrants can afford to borrow.

-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Simple example

in todays money Mr Smith can afford to make mortgage payments of say £700 / month at say 2% interest rates.

When rates go to 4% this will make his mortgage £1100 / month (I made that up, but you get the idea).

Uh oh...Mr Smith can't afford that, he just took out a 3 year lease on a flash car his income doesn't really match. Oops.

 

Meanwhile Mrs First-Timer was told she could borrow £250,000 for her first house, because the careless lender worked out she can afford the £600 per month that the loan will cost her.

Then interest rates go up. That same £600 / month will only support a loan for £220,000. She now has less to spend on a first house, but so do all the other First Timers, so anyone wanting to sell their first time buyers house for £250,000 is going to find they have no takers, no one will be able to borrow that kind of money.

"Hmm, if I drop the price of my house to £220,000 it will sell quickly, maybe I'd better do that now before things start to get worse - rates are probably going to rise again soon" said the not too stupid house seller.

Soon lots of people start doing the same thing. Soon people start saying housing is a bad investment. Interest rates keep going up. Lots of hard working and fully deserving baby boomers sell their grotty 1970s décor houses at knocked down prices as they cart themselves off to smaller dwellings. Houses become something that all the "experts" tell us was a bad idea to have put our money into.

Ten years later, rates start coming down, and people completely forget what happened last time. Feeling a little bit flush buyers start to get a bit cocky, and lenders a little bit confident. This is the time you should be buying your second "investment" property to sit on, and this time you too can laugh all the way to the bank. Or perhaps we'll have a government that stops this stupid obsession.

Edited by wsn03

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I'm amazed mortgage rates keep dropping. I'm applying for a remortgage on my house and have been offered 1.59% on a 5 year fix. Why are banks offering such low fixed rates when we keep hearing rates are going to rise?

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On 12/07/2017 at 4:16 PM, lombardo said:

Will an IR rise only help those with lots of cash  or a big deposit?

It will make saving a deposit worthwhile and prevent you being outbid by someone willing to take crazy risks with their personal finances.

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15 hours ago, Habeas Domus said:

However high interest rates tend to be followed by inflation, if everything has doubled in price after 10 years, then your mortgage costs will have halved relative to your wages. Assuming that you pay at least the interest every year so the debt is not growing. This is where the idea of the housing ladder comes from - after a few years you can trade up to a bigger house still paying the same proportion of your salary.

Ultra Low interest rates create the opposite - a "housing ladder" where it will take you 100 years of saving to reach the next rung. A lot of house buyers are currently in a situation where the first house they buy is likely to be all they will ever be able to afford.

This is what happened in the 70s and 80s.  Inflation was high and rates kept rising.  Every so often we got letters saying our monthly payments on our repayment mortgage was increasing which was quite worrying at the time but it was also a time when HPI was happening and by making the higher payments it was possible to climb the "ladder".  The perceived wisdom was to take on the highest mortgage you could afford as prices were rising.  This is where the current mind-set comes from as boomer parents pass on this bit of wisdom to their offspring.  But it's different now and a lot having maxed out will find out the hard way it's not a sustainable way to live.

I remember too people losing out big time in the early 90s with their houses being repossessed and prices fell then.

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9 hours ago, interestrateripoff said:

Fixed rates and teaser rates complicate any increase in the base rate.  Those on SVR and BoE trackers take the brunt.

What happens if rates raise is probably a slow burn.  Although in terms of borrowing people it seems are maxed out.

Yes that is true and the problem with using such a basic formula is that it's tricky to consider the impact of rate moves, fixed falling onto an SVR etc. There;s ways to overcome this of course but they're probably beyond the scope of this blog. 

They key wording though is 'discount rate' or 'cost of capital'. The base rate may rise of fall but that's only really for people dealing with the BoE. What matters is the cost of credit to the punter. I take the point though, if base rates are rising then cet. par. we would expect borrowing costs to increase. 

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9 hours ago, btd1981 said:

Some interesting analysis above, but don't fantastic schemes like the Term Funding Scheme render this purely academic?

Yes and no.

The question is how do we value a house? Using my basic method is flawed because we need to take income, minus costs and depreciation of the building (houses don't ever increase in price unless there's some sort of rarity value, it is the land with the permission to have a house on it that's increasing).

The Term Funding Scheme serves to lower the cost of borrowing to the end borrower and really that's all that matters. If the cost of borrowing increases then the value of a property falls - pretty obvious right? But what's interesting to me is the sensitivity to interest rates. This works in reverse of course so we could look at how much we;d expect a property to appreciate by if they dropped rates to the floor. 

The other variable is the income stream. If that falls then we can also expect falls in property prices. 

I'm speaking of course from an investment perspective. My personal view is that I love my home and as long as I can afford it I'm not fussed about all this... it is as you say an academic folly. :) 

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2 hours ago, wsn03 said:

I got a bit lost with some of the answers, so apologies if this has been written already.

In short, a rise in interest rates will make mortgage payments more expensive. This will put people who are maxed out into distress, in extreme cases they will be forced to sell (giving up or even repossessed).

The increased costs will reduce the amount people can afford to borrow. This will give them less spending power, meaning new entrants to the market won't be able to pay as much for a house as they could before. When this happens to enough new entrants, and more houses start coming on the market due to distressed / forced sellers, something has to give. Those who want to sell eventually start lowering their sale prices into the range of the reduced amount the new entrants can afford to borrow.

-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Simple example

in todays money Mr Smith can afford to make mortgage payments of say £700 / month at say 2% interest rates.

When rates go to 4% this will make his mortgage £1100 / month (I made that up, but you get the idea).

Uh oh...Mr Smith can't afford that, he just took out a 3 year lease on a flash car his income doesn't really match. Oops.

 

Meanwhile Mrs First-Timer was told she could borrow £250,000 for her first house, because the careless lender worked out she can afford the £600 per month that the loan will cost her.

Then interest rates go up. That same £600 / month will only support a loan for £220,000. She now has less to spend on a first house, but so do all the other First Timers, so anyone wanting to sell their first time buyers house for £250,000 is going to find they have no takers, no one will be able to borrow that kind of money.

"Hmm, if I drop the price of my house to £220,000 it will sell quickly, maybe I'd better do that now before things start to get worse - rates are probably going to rise again soon" said the not too stupid house seller.

Soon lots of people start doing the same thing. Soon people start saying housing is a bad investment. Interest rates keep going up. Lots of hard working and fully deserving baby boomers sell their grotty 1970s décor houses at knocked down prices as they cart themselves off to smaller dwellings. Houses become something that all the "experts" tell us was a bad idea to have put our money into.

Ten years later, rates start coming down, and people completely forget what happened last time. Feeling a little bit flush buyers start to get a bit cocky, and lenders a little bit confident. This is the time you should be buying your second "investment" property to sit on, and this time you too can laugh all the way to the bank. Or perhaps we'll have a government that stops this stupid obsession.

You're on the right tracks but we just borrowed £367k at 1.54% fixed for two years. They stress tested us to 10.99% which would horrible but we could afford it. 

If you are talking crash terms then yes a massive hike in interest rates resulting in them being higher than the stress tested levels would push people over the edge but they'd need to increase by more than 2% realistically. 

I'm looking at the sensitivity of values from an income steam perspective while your vision is very binary - they can afford the mortgages until they can't and then bang forced sellers escaping the property trap and selling up. 

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10 hours ago, Greg Bowman said:

Very good post and I suspect you didn't have to take your socks off to use your toes for counting :P

Thanks :)

No toes on this one as I kept the rates under 5% :D 

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