It’s time to lock in your mortgage rate…ASAP!

Most of us dream of the day when we can burn our mortgage. Few of us are prepared for the day when the mortgage burns our dreams of home ownership.

For some, the added expense of renewing their mortgage at a higher rate of interest can come as a shock. The rates offered today are crazy low by historical standards. Young homeowners weren’t subjected to skyrocketing mortgage rates during the early 1980’s and God willing they never will.

I recall being asked – long ago when friends thought I was prescient just because I worked in the financial industry – whether or not one should lock in the mortgage rate for the long term since it seemed like they’d just keep going higher. After all, in 1982 the trajectory of interest rates and mortgage rates had been straight UP!

As you can imagine, my answer at the time was an emphatic “NO!”

Today the opposite is true. The cheapest posted mortgage rates are the ones with the shortest terms or are variable. Plug those rates into your calculator and the payment schedule seems like a dream come true. Unfortunately interest rates over short time horizons can be surprisingly volatile. It’s possible just one or a few years later you’re burdened with payments that are no longer manageable.

In March of 1987 the average mortgage rate was close to 10%, but by March of 1990 had climbed to 13.5%. The monthly payment for a $500,000 mortgage at 10% (crude calculations but I am lazy) might have been around $4800. But at 13.5% would be nearly $6000. If you or your partner were lucky enough to get a $15,000 raise over the course of the term (say 3-year in this example) then things would be okay, but otherwise your consumption (food, child’s education, gasoline) or savings plan would suffer. Worst case, you’d have to sell the house.

Strangely enough, housing prices can rise during the early stages of rising interest rates as people who were planning to buy a house begin to hurry up the process, hoping to get a more attractive mortgage rate (before they go any higher). Unfortunately, the panic to buy is short-lived and soon there is a veritable drought of buyers who can’t afford to hold mortgages at the higher rates. Suddenly, there’s a glut of houses for sale, and if you can’t manage the higher monthly payments you have to sell the house at a loss. OUCH!

The process of rising interest rates has already begun in earnest. Historically, mortgage yields are slightly above bond yields. Bond yields go up, mortgage rates go up too. Financial institutions have responded to rising bond yields (see graph) by raising their mortgage rates in recent months as I’m sure you’ve noticed. At present, mortgage rates haven’t risen as much though, because these institutions continue to compete with one another by offering incentives and there’s also a bit of a lag as head office communicates its changes in corporate strategy down to the marketing departments.

There is still a bit of time to buy your dream home and walk away with a low-rate mortgage, but not nearly as much time as you might think. You might be reading that governments are inclined to keep the ‘bank rate’ (or discount rate which is the rate of interest the central bank charges the commercial banks to borrow money) low, in order to help the economy along. This policy is long-in-the-tooth already, and central banks cannot continue lending money to the banking system at a ridiculously low rate, when the interest rates the central banks have to pay to raise money for government spending (bond rates) keep rising. The strain on the country’s finances will become too onerous, and unwanted inflation inevitable.

If you haven’t taken advantage of low mortgage rates yet, go ahead and lock up your rate at the lending institution for as long a term as possible. And if you’ve been holding off buying that new car, don’t wait. I’ve been in the financial industry long enough to know a good thing when I see it and I took advantage of one of those generous 0% financing offers – I figure I may not see another opportunity like it in my lifetime.

Mal Spooner

 

 

 

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Is it the 1950’s again? The financial war is over!

There is a plethora of articles and blogs out there desperately trying to find a period comparable to now, in order to get some understanding of what markets might have in store for us over the next several years.  After three decades in the investment business, the only thing I can say with certainty is that such comparisons just don’t work.

George Santayana (December 16, 1863 – September 26, 1952) the philosopher and man of letters, is often quoted: “Those who cannot learn from history are doomed to repeat it.

It’s true people will make the same mistakes over and again, but history never actually repeats itself.  Trying to forecast the future is absurd, and so it must be even more ridiculous to expect that the future will be similar to some time period long ago.  Nevertheless, it’s winter and all my friends are on vacation so I’ve nothing else to do.

Post-War Reconstruction: In my simple mind, we’ve just fought a global war against financial corruption.  The weapon of mass destruction?  The ‘derivative!’ These things managed to infiltrate the entire global banking system and almost brought it crumbling down.  Like most wars, it’s difficult to put a pin into when things flipped from a crisis to all out war, but let’s say the seeds were planted when the U.S. Senate tried to introduce a bill in 2005 to forbid Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) from holding mortgage-backed securities (pretend capital) in their portfolios. That first cannonball missed the mark when the bill failed to pass.  By 2007 the two government sponsored entities were responsible for 90% of all U.S. mortgages, and the fly in the ointment was the use of ‘derviatives’ instead of real capital to hedge their interest-rate risk.   Banks did the same thing but much more aggressively. What followed is a long story we’ve been living for years.

Paul Volcker once said, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”  Well, we’ve plenty of evidence now that financial innovation led only to the mass destruction of wealth.

When the foundation fell out from under us (value of the derviatives dropped) we went to war in earnest.  The list of casualties like Lehman Brothers Holdings Inc. (announced September 15, 2008 it was bankrupt) just kept getting longer.

I believe the war ended six years after that failed 2005 Senate bill – in the summer of 2011. You can disagree, but your opinion is as meaningless as this whole exercize. (Laughing out loud.)

Way back when World War II (1939 – 1945) ended, governments around the globe began to print money and spend to rebuild the wealth that had been destroyed.  Isn’t this precisely what we’ve been doing since our financial crisis decimated wealth on a global scale?

So maybe some of what happened in the 1950’s post-war period will happen again?

In 1949 there was a brief struggle with the threat of deflation (and again in 1954) but for most of the decade inflation remained steady between 0% to 3%. We too saw the threat of deflation briefly in 2009.  However since then inflation has been fairly steady:  1.5% (December to December) in 2010 and 3.2% in 2011 in the U.S.  Although T-bills are currently paying a negative real rate of return (yields are below the inflation rate) there will come a time soon when investors insist on earning something or they just won’t hold them.  Short term rates will climb as they did throughout the 1950’s.

Prediction #1:  T-Bills will begin to rise until their returns cover the rate of inflation (see chart).

What happened in the stock market back then?  Government spending to rebuild infrastructure and create jobs had a significant impact, because arguably the 1950’s was one of the best if not the best decade for making money in the stock market.  Unfortunately, we only have reliable data for the Dow Jones Industrial Average dating back that far (okay, there might be more data out there but I’m surely not going to go looking for it). 

At the end of 1949 the Dow was at 200.13 and by the end of 1959 it had climbed to 679.36.  Excluding dividends that equates to a (IRR) return of about 13% per year for a decade.  As always lots of volatility had to be endured in stocks, but in the long run the reward was not shabby!  On the other hand, in Treasury bonds you might have averaged a 2% return, but suffered an actual loss in 5 out of the 10 years.

Prediction #2: Global growth fueled by government initiatives will translate into healthy returns on average in stock markets for several years to come.

Are we doomed to repeat history?  Although the 1950’s turned out okay, a wild ride was to come during the following couple of decades.  Easy money and inflation would eventually get the better of us and although there were some very good years for investors in the stock market (and those invested in shorter term T-bills for sure), inflation mayhem was on its way.

All we can hope for is that today’s policy makers have studied their history.  If we allow inflation to get out of control, interest rates will skyrocket like they did through the 60’s and 70’s. Younger folks today will have to suffer rising interest rates (mortgages, car loans) of the sort that created havoc for decision-makers and choked economic growth to a standstill for us older generations back in the day.

It’s true that if we don’t learn from history, we can and will make the same mistakes over again.  But I also said history does not repeat itself.  Although we somehow managed to eventually wrestle the inflation bogieman under control before, this does not mean we will be so lucky next time around.  And it’s a wealthier more technologically advanced world we live in now….which means we’ve so much more to lose if we really screw things up.

Prediction #3:  If governments don’t slow down their spending, bond investors will really get burned.

My instincts tell me that 2013 will be a happy New Year.  And bear in mind that if none, any or all of these predictions come true it will be an unadulterated fluke.

 

 

 

 

Malvin Spooner.