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Interest rates are pretty low right now and a few of my friends are rushing to buy a house(even though the actual property prices are pretty high.) I was of an opinion that mortgage rates being low is not a reason enough to buy a house, one should buy when they are ready and set.

However, I came across this chart

http://www.freddiemac.com/pmms/pmms30.htm

I am so surprised that the rates used to be more than 10%. If so, a mortgage less than 4% sounds like a dream to me. Now, I have a few question

  1. As of now in 2016, is is safe to assume that mortgage rates would/should not get back to 10%?
  2. Does this mean that one should always buy a house ONLy when mortgage rates are low? Is it worth the wait IF the rates are high right now?
  3. Is refinancing an option on the table, if I made a deal at a bad time when rates are high?
  4. How can people afford 10% mortgage?
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The best time to buy a house is when interest rates are high (in their cycle) as prices are lower (in their cycle). When interest rates are at a high level that is causing the economy (and house prices) to stall you know that the risk of rates going higher is low and the risk will be all on the downside (for rates). So by buying when rates are high, you pay less for a property and after a short period will be paying less on your mortgage (if you took out a variable loan). You win on both lower house price and lower rates (after a short while). – Victor Mar 20 at 20:34
    
Most people just buy when rates are low, house prices are high and all the risk is on the upside for rates (and lower house prices going forward). That is why most people like your friends will end up in financial difficulties. – Victor Mar 20 at 20:36

The simple answer is that you are correct. You should not purchase a house until you are financially stable enough to do so. A house is an asset that you must maintain, and it can be expensive to do so.

Over the long term, you will generally save money by purchasing. However, in any given year you may spend much more money than a similar rental situation - even if the rent is higher than your mortgage payment. If you are financially stable with good cash savings or investments plus a 20% down payment, then anytime is a good time to buy if that is part of your financial plan.

As of now in 2016, is is safe to assume that mortgage rates would/should not get back to 10%? Does this mean that one should always buy a house ONLy when mortgage rates are low? Is it worth the wait IF the rates are high right now?

The mortgage rates are not the primary driver for your purchase decision. That might be like saying you should buy everything on sale at Target... because it's on sale. Don't speculate on future rates. Also, keep in mind that back when rates were high, banks were also giving much better savings/CD rates. That is all connected.

Is refinancing an option on the table, if I made a deal at a bad time when rates are high?

You need to make sure you get a loan that allows it. Always do a break-even analysis, looking at the money up-front you spend to refi vs the savings-per-year you will get. This should give you how many years until the refi pays for itself. If you don't plan on being in the house that long, don't do it.

How can people afford 10% mortgage?

Buying a house they can afford, taking into consideration the entire payment+interest. It should be a reasonable amount of your monthly income - generally 25% or less. Note that this is much less than you will be 'approved' for by most lenders.

Don't let good rates suck you into a deal you will regret. Make sure you have the margin to purchase and maintain a home. Consider where you want to be living in 5 years. Don't leave so little financial breathing room that any bump will place you at risk of foreclosure.

That said, home ownership is great! I highly recommend it.

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Not that this should be a primary driver at all, but mortgage interest is also deductible if you itemize your deductions on your tax forms. So a higher interest rate means you pay more in interest, and you therefore get a bigger deduction. (Assuming you financed the same amount.) – GalacticCowboy Mar 18 at 18:25
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I would say that if you're already in a situation where you want, and are able, to buy a house, an expectation of rising interest rates should drive you to buy a bit sooner than you would. Mortgage rates aren't totally out of the picture. It's just that there are many other considerations that come first. – hobbs Mar 19 at 3:02
    
@GalacticCowboy: Your loan amount or interest rate has to be insanely high for mortgage interest to exceed the standard deduction. Itemized deductions are basically utterly worthless for ordinary people who actually have to worry about money. – R.. Mar 19 at 16:59

There is a significant tie between housing prices and mortgage rates. As such, don't assume low mortgage rates mean you will be financially better off if you buy now, since housing prices are inversely correlated with mortgage rates. This isn't a huge correlation - it's R-squared is a bit under 20%, at a 1.5-2 year lag - but there is a significant connection there. Particularly in that 10%+ era (see chart at end of post for details) in 1979-1982, there was a dramatic drop in housing price growth that corresponded with high interest rates.

There is a second major factor here, though, one that is likely much more important: why the interest rates are at 10%. Interest rates are largely set to follow the Federal Funds rate (the rate at which the Federal Reserve loans to banks). That rate is set higher for essentially one purpose: to combat inflation. Higher interest rates means less borrowing, slower economic growth, and most importantly, a slower increase in the money supply - all of which come together to prevent inflation.

Those 10% (and higher!) rates you heard about? Those were in the 70's and early 80's. Anyone remember the Jimmy Carter years? Inflation in the period from 1979 to 1981 averaged over 10%. Inflation in the 70s from 1973 to 1982 averaged nearly 9% annually. That meant your dollar this year was worth only $0.90 next year - which means inevitably a higher cost of borrowing.

In addition to simply keeping pace with inflation, the Fed also uses the rate as a carrot/stick to control US inflation. They weren't as good at that in the 70s - they misread economic indicators in the late 1970s significantly, lowering rates dramatically in 1975-1977 (from ~12% to ~5%). This led to the dramatic double-digit inflation of the 1979-1981 period, requiring them to raise rates to astronomic levels - nearly 20% at one point. Yeah, I hope nobody bought a house on a fixed-rate mortgage from 1979-1981.

The Fed has gotten a lot more careful over the years - Alan Greenspan largely was responsible for the shift in policy which seems to have been quite effective from the mid 1980s to the present (though he's long gone from his spot on the Fed board). Despite significant economic changes in both directions, inflation has been kept largely under control since then, and since 1991 have been keeping pretty steady around 6% or less. The current rate (around 0%) is unlikely to stay around forever - that would lead to massive inflation, eventually - but it's reasonable to say that prolonged periods over 10% are unlikely in the medium term.

Further, if inflation did spike (and with it, your interest rates), salaries tend to spike also. Not quite as fast as inflation - in fact, that's a major reason a small positive inflation around 2-3% is important, to allow for wages to grow more slowly for poorer performers - but still, at 10% inflation the average wage will climb at a fairly similar pace. Thus, you'd be able to buy more house - or, perhaps a better idea, save more money for a house that you can then buy a few years down the road when rates drop.

Ultimately, the advice here is to not worry too much about interest rates. Buy a house when you're ready, and buy the house you're ready for. Interest rates may rise, but if so it's likely due to an increase in inflation and thus wage growth; and it would take a major shift in the economy for rates to rise to the 10-11% level. If that did happen, housing prices (or at least growth in prices) would likely drop significantly.


Some further references:

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+1 for being the only answer which mentions that house prices are correlated to mortgage rates. – Navin Mar 19 at 4:40
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Since owning a house is usually a long-term plan (even if you swap one house for another one along the way) the long term effects of moderate inflation on mortgage payments is huge. For example I bought a house (in the UK) back in the 1980s on a 25-year mortgage at about 8% interest. After 25 years of inflation, the payments were peanuts - about £20 a week (say $30). The value of the house in money terms was more than 10 times what I paid for it back then. But that is a misleading way to look at the situation, because in real terms, it's still worth "one average sized house". – alephzero Mar 19 at 23:29

How can people afford 10% mortgage?

Part of the history of housing prices was the non-bubble component of the bubble. To be clear, there was a housing bubble and crash. Let me offer some simple math to illustrate my point -

enter image description here

This is what happened on the way down. A middle class earner, $60K/yr couple, using 25% of their income, the normal percent for a qualified mortgage, was able to afford $142K for the mortgage payment. At 10% fixed rate. This meant that after down payment, they were buying a house at $175K or so, which was above median home pricing.

Years later, obviously, this wasn't a step function, with a rate of 4%, and ignoring any potential rise of income, as in real term, income was pretty stagnant, the same $1250/mo could pay for a $260K mortgage. If you want to say that taxes and insurance would push that down a bit, sure, drop the loan to $240K, and the house price is $300K.

My thesis ('my belief' or 'proposal', I haven't written a scholarly paper, yet) is that the relationship between median home price and median income is easily calculated based on current 30 year fixed rate loans. For all the talk of housing prices, this is the long term number. Housing cannot exceed income inflation long term as it would creep up as a percent of income and slow demand. I'm not talking McMansion here, only the median. By definition, the median house targets the median earners, the middle class.

The price increase I illustrate was just over 70%. See the famous Shiller chart -

enter image description here

The index move from 110 to 199 is an 81% rise. I maintain, 70 of that 81 can be accounted for by my math. Late 80's, 1987 to be exact, my wife got a mortgage for 9%, and we thought that was ok, as I had paid over 13% just 3 years earlier.

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The US-centricism of that chart is obvious: WWII began in (September) 1939, not 1941 as indicated. – Michael Kjörling Mar 18 at 15:31
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@MichaelKjörling The chart states that it's "an index of American housing prices" in the text. – Michael McGriff Mar 18 at 16:13
    
I agree this is a component, but it's definitely not all of it or even all that large a component: when I was researching my answer, the tie both to income and to interest rates was mediocre. Just too many conflating issues that affect home prices. – Joe Mar 18 at 17:29
    
@MichaelKjörling - the question was tagged US. And I'm pretty sure the bubble wasn't felt as greatly in other countries. – JoeTaxpayer Mar 18 at 17:30
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@Joe - I appreciate a good counter argument, so far my numbers show a very high correlation. Not sure what you offer to the contrary. – JoeTaxpayer Mar 18 at 17:32

As of now in 2016, is is safe to assume that mortgage rates would/should not get back to 10%?

What would the rates be in future is speculation. It depends on quite a few things, overall economy, demand / supply, liquidity in market etc ... Chances are less that rates would show a dramatic rise in near future.

Does this mean that one should always buy a house ONLy when mortgage rates are low? Is it worth the wait IF the rates are high right now?

Nope. House purchase decision are not solely based on interest rates. There are quite a few other aspects to consider, the housing industry, your need, etc. Although interest rate do form one of the aspect to consider specially affordability of the EMI.

Is refinancing an option on the table, if I made a deal at a bad time when rates are high?

This depends on the terms of current mortgage. Most would allow refinance, there may be penal charges breaking the current mortgage. Note refinance does not always mean that you would get a better rate.
Many mortgages these days are on variable interest rates, this means that they can go down or go up.

How can people afford 10% mortgage?

Well if you buy a small cheaper [Less expensive] house you can afford a higher interest rate.

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If you buy a "cheaper" (or "less expensive") house then you can afford a higher interest rate. A smaller house is not necessarily cheaper, because all else tends to not be equal. – Michael Kjörling Mar 18 at 15:33
    
@MichaelKjörling Valid point. – Dheer Mar 18 at 16:15

Reasons for no:

  1. In your first sentence you say something interesting: rates low - prices high. Actually those 2 are reversely correlated, imagine if rates would be 5% higher-very few people could buy at current prices so prices would drop. Also you need to keep in mind the rate of inflation that was much higher during some periods in the US history(for example over 10% in the 1980) so you can not make comparisons just based on the nominal interest rate.

  2. Putting all your eggs in one basket. If you think real estate is a good investment buy some REITs for 10k, do not spend 20% of your future income for 20 years.

  3. Maintenance - people who rent usually underestimate this or do not even count it when making rent vs mortgage comparisons.

Reasons for yes:

  1. Lifestyle decision - you don't want to be kicked out of your house, you want to remodel...

  2. Speculation - I would recommend against this strongly, but housing prices go up and down, if they will go up you can make a lot of money.

To answer one of questions directly: 1. My guess is that FED will try to keep rates well bellow 10% (even much lower, since government can not service debts if interest rates go much higher), but nobody can say if they will succeed.

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