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I'm looking to buy a property. I do not want to take a risk on this property. Its sole purpose is to provide me with a place to live. How would I go about hedging against increasing interest rates, to counter the increasing mortgage costs?

Ideally I'd like to not lose money on my property, seeing as I will be borrowing 95% of the property's value. So, I'd like to hedge against interest rates and falling property prices in order to have a risk neutral position on my property.

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    If its sole purpose is to provide you a place to live and if you don't want to risk any risks, you need to rent rather than buy. – ChrisInEdmonton Oct 29 '13 at 13:28
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    Does it make sense to mix financial concerns (risk) with life choices (my home)? Homes are not investments. – Joe Strazzere Oct 29 '13 at 13:47
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    ChrisInEdmonton, renting is a risk as well, your landlord might increase the rent, and being forced to move house will not be fun. – newlogic Oct 29 '13 at 14:04
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    @GeorgeMarian - Thank you for appreciating my cute semantics. Really. I was trying to make one point. The life choice (house) carries financial risk. JoeS is right, in my opinion, to not consider the house an investment, but there's no ignoring that it's still a financial matter as well. – JoeTaxpayer Oct 29 '13 at 16:12
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    @kaz - Please forgive my tone - in 1980 30 year mortgages averaged 13.75%. What do you mean by ridiculously low? And why are they still paying after 33 years? – JoeTaxpayer Oct 29 '13 at 22:20
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To avoid risk from rising interest rates, get a fixed rate mortgage. For the life of the mortgage your principal and interest payments will remain the same. Keep in mind that the taxes and insurance portion of your monthly payment may still go up.

Because you own the property, the costs to maintain the property are your responsibility. If you rented this would be the responsibility of the owner of the property; if the cost to repair and maintain goes up so does the rent. Because you are the owner your annual costs to repair and maintain may go up over time.

The way to eliminate risk of loss of value is to never move, until the mortgage is paid off. You will know exactly what principal and interest will cost you over the life of the loan. When you sell that will be essentially return on your payments.

You don't know if the loss of value is due to world, national, regional, local or individual circumstances. so hedging is tough.

If the fact that the mortgage is 95% is what makes you nervous, your biggest risk is risk of being upside down. That risk is greatly reduced by increasing the amount of the down payment. That decreases the risk that the value will be below the mortgage amount if due to unforeseen circumstances you have to sell immediately. The money will still be lost due to decrease in value, but you aren't forced to bring cash to the settlement table if you need to sell.

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    +1, but I can't help but think that risk rises for the owner by owing less, not more. The 5% down owner can (in most states) walk away leaving the bank holding the property if prices drop 20%. The fully paid house? The owner has all the risk. – JoeTaxpayer Oct 29 '13 at 23:48
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    If they walk away they may still be on the hook for the money, they may still owe taxes on the forgiven amount and their credit is destroyed. If they own the house they will still be able to get some cash, and won't destroy their credit. The equity protects them from that risk. – mhoran_psprep Oct 30 '13 at 9:56
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How can one offset exposure created by real-estate purchase? provides a similar discussion. Even if such a product were available in the precise increments you need, the pricing would make it a loser for you. "There's no free lunch" in this case, and the cost to insure against the downside would be disproportional to the true risk. Say you bought a $100K home. At today's valuations, the downside over a given year might be, say, 20%. It might cost you $5000 to 'insure' against that $20K risk.

Let me offer an example - The SPY (S&P ETF) is now at $177. A $160 (Dec '14) put costs $7.50. So, if you fear a crash, you can pay 4%, but only get a return if the market falls by over 14%. If it falls 'just' 10%, you lose your premium.

With only 5% down, you will get a far better risk-adjusted return by paying down the mortgage to <78% LTV, and requesting PMI, if any, be removed. Even if no PMI, in 5 years, you'll have 20% more equity than otherwise. Over the long term, 5 year's housing inflation would be ~ 15% or so. This process would help insure you are not underwater in that time. Not guarantee, but help.

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Note: I am making a USA-assumption here; keep in mind this answer doesn't necessarily apply to all countries (or even states in the USA). You asked two questions:

I'm looking to buy a property. I do not want to take a risk on this property. Its sole purpose is to provide me with a place to live. How would I go about hedging against increasing interest rates, to counter the increasing mortgage costs?

To counter increasing interest rates, obtaining a fixed interest rate on a mortgage is the answer, if that's available. As far as costs for a mortgage, that depends, as mortgages are tied to the value of the property/home. If you want a place to live, a piece of property, and want to hedge against possible rising interest rates, a fixed mortgage would work for these goals.

Ideally I'd like to not lose money on my property, seeing as I will be borrowing 95% of the property's value. So, I'd like to hedge against interest rates and falling property prices in order to have a risk neutral position on my property.

Now we have a different issue. For instance, if someone had opened a fixed mortgage on a home for $500,000, and the housing value plummeted 50% (or more), the person may still have a fixed interest rate protecting the person from higher rates, but that doesn't protect the property value. In addition to that, if the person needed to move for a job, that person would face a difficult choice: move and sell at a loss, or move and rent and face some complications.

Renting is generally a good idea for people who (1) have not determined if they'll be in an area for more than 5-10 years, (2) want the flexibility to move if their living costs rises (which may be an issue if they lose wages), (3) don't want to pay property taxes (varies by state), homeowner's insurance, or maintenance costs, (4) enjoy regular negotiation (something which renters can do before re-signing a lease or looking for a new place to live). Again, other conditions can apply to people who favor renting, such as someone might enjoy living in one room out of a house rather than a full apartment or a person who likes a "change of scenes" and moves from one apartment to another for a fresh perspective, but these are smaller exceptions.

But with renting, you have nothing to re-sell and no financial asset so far as a property is concerned (thus why some real estate agents refer to it as "throwing away money" which isn't necessarily true, but one should be aware that the money they invest in renting doesn't go into an asset that can be re-sold).

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    The owner pays property tax, so the cost is built into the monthly rent. The owner generally purchases property insurance, again building the cost into the rent they charge. If these costs go up there is pressure to raise the rent. The renter should also buy renters insurance to protect their stuff. – mhoran_psprep Oct 29 '13 at 19:26
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    Good answer first piece, but 'how to hedge falling home price' is similar to my "you cant" – JoeTaxpayer Oct 29 '13 at 19:26
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    Though an owner purchases property insurance, it may not extend to cover the belongings of a renter. If you rent, you need your own insurance. (This is the case where I live; your mileage may vary. And many renters do not know this, where I live. If the property burns down, they get nothing.) – Kaz Oct 29 '13 at 19:51
  • @Kaz Agreed; though generally renter's insurance is significantly cheaper than homeowner's insurance with some exceptions applying. Thanks Joe; I wanted to weigh in on where I think some conditions might favor renting and why, from an investing perspective, there are benefits associated with it. – Question3CPO Oct 31 '13 at 18:14
  • In my experience, homeowners get far more opportunities to practice their negotiation skills than renters. Every home improvement project or landscaping decision involves choices, including cost-based choices. Renters usually just have to negotiate lease-renewals and convince the landlord to fix problems. – Jasper Nov 3 '15 at 6:18
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It is pretty simple to avoid risk in home ownership:

  1. Fixed rate interest rate.
  2. 15 year mortgage, or 10 if you can swing it. Today's interest rates make that possible.
  3. Do your own escrow. About 90% of escrow accounts are "screwed up", take control of it yourself so your mortgage payments stay fixed.
  4. Borrow only 80%.
  5. Have a 6 months of living expenses emergency fund in place.

Do those things and your risk of home ownership is about nil.

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    Your answer is pretty good, although with rates so low, the difference between 30 and 15 year payments is worse, not better, nearly 50% higher for the 15. But. The OP wants a hedge against a 2005-like price drop. How does any of your good advice help? Last - do you have a citation for 90% of escrow accounts are screwed up? – JoeTaxpayer Oct 30 '13 at 14:40
  • I don't have a citation, for the escrow probably too much of an exaggeration. Here in Florida property taxes are due in April or so. If you pay in November, you get a 5% discount. Escrow companies will not take advantage of that. With my first house, I insisted that they pay the taxes to take advantage of the discount. Then the software bumped my payment because I had a low balance, but needed to pay taxes in April (although they were already paid). Being on the phone with barely competent workers is worth not having to do escrow. – Pete B. Oct 30 '13 at 14:58
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You can hedge your house price from losing value if you believe that the housing market is correlated with major stock indices. Speak with a commodities broker because they will be able to help you buy puts on stock indices which if correlated with housing prices will offer somewhat of a hedge. Example. House prices drop 30% because of weak economy, stocks will generally drop around that same amount 30%. If you have enough exposure to in the puts compared to your house value you will be protected. You can also buy calls in 30 year bonds for interest rate lock if you are not on a fixed interest rate. Many investors like warren buffet and carl icahn have been protecting them selves from a potential market downward turn. Speak to a local commodity broker to get some detailed advice, not etrade or any discount brokers they won't be able to help you specialize your trades. look for a full time commodity broker house.

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    I believe my answer went into detail as to how this is a failing strategy. A 1 year at-the-money put costs just under 7%. (Looking at Dec 14, so nearly 14 mo) How does using this strategy balance risk? – JoeTaxpayer Nov 1 '13 at 20:15

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