Why 13% Interest Rates In 1980 Were Effectively LOWER Than Today’s; Real Rates vs. Nominal Rates
Mortgage interest rates were just under 19% in the early 1980s, as shown in this table by Freddie Mac, going back to 1971.
BUT, “real rates” were sometimes LOWER than where they are today.
This was a point that an inflation hawk made on a podcast I listened to recently.
He borrowed money to finance his first home in 1980 at a rate of 13% – and his “mother cried,” he said because her first house was financed at 3%.
But, he also said he was delighted with his rate because inflation was raging at 15% at the time, so his “real interest rate” was a negative 2%!
What he was really trying to do though was illustrate the difference between “real” and “nominal” interest rates.
The nominal interest rate is the actual interest rate on a promissory note or a debt instrument.
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REAL INTEREST RATES ADJUST FOR INFLATION
The real interest rate is the nominal rate minus the rate of inflation, and it reflects the actual cost of funds that a borrower is paying.
According to the Consumer Price Index, inflation averaged 1.3% last year.
So, a borrower with a 2.875% nominal rate has a real rate of approximately 1.6%.
And, according to the inflation hawk quoted above, that would make today’s rate effectively higher than 1980’s.
Investors and lenders of course never want to see nominal interest rates lower than inflation rates because if they do, there is little reason to lend money (because they will get paid back with dollars that are less valuable than the dollars they loaned).
And this is one of the reasons why inflation signals are such a concern – investors will likely demand higher rates in order to ensure their returns are adequate in the face of inflation.
From a consumer’s perspective, this is a good analysis to consider if and when rates do rise as a result of inflation.
Borrowing at much higher rates may not be such a bad idea if inflation rates are close to (or even higher) than nominal rates; it’s all about the effective cost of funds with inflation taken into account.
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