Mortgage Rates Are More Of A Gift Than Ever!
I often write that the market’s very low interest rates are a gift because they are so low by historical standards! (and it’s true)
And, they are more of a gift than ever before now, despite the fact they have risen by 1/2% since last summer, and I will explain why below.
What Are Negative Rates? (Portuguese Bank Pays Borrower!)
This WSJ article discusses a Portuguese borrower with a $380,000 mortgage who actually gets paid every month by the bank that holds her mortgage – because her interest is “minus 0.25%.”
Instead of making a mortgage payment, the borrower actually gets $45 from the bank.
So, a “negative rate” is an interest rate that is below 0% and that requires banks (that hold mortgages) to actually pay borrowers.
In an effort to stimulate the economy, the European Central Bank (ECB) cut interest rates below zero back in 2014.
The ECB thought this would stimulate the economy by eliminating interest expenses which would in turn encourage more borrowing and spending (with borrowed funds or with money not spent on interest) by both consumers and businesses.
They also thought it would be a temporary measure … but not so much.
WHY WOULD A BANK OR INVESTOR TAKE A NEGATIVE INTEREST RATE?
Here are a few reasons why investors or banks might buy or hold investments with negative yields.
- Didn’t Expect Rate To Go Negative. Some of the mortgages in Europe with negative rates are “adjustable” and the banks did not expect the indexes to which they are tied to go negative when they made the loan.
- Expect Deflation. If a lender or investor expects deflation as opposed to inflation, a negatively yielding investment can still appreciate or be worth more in terms of goods and services it can be exchanged for over time.
- Forced To. Some lenders or investors are forced to make loans or to buy negatively yielding investments by regulators.
- Safer Than Cash. Some investors consider negatively yielding investments to be safer than cash.
WHY BORROWERS “ENJOY” NEGATIVE RATES IN THE U.S.
Inflation is running close to a 7% rate, according to the latest Consumer Price Index (CPI) data. The Producer Price Index indicates that inflation is closer to 10%. And many pundits claim inflation is well over 10% because the CPI does not properly account for energy and housing costs, among other things.
As of January 12, 2022, the average interest rate in the U.S. according to Freddie Mac’s data, is about 3.5%, while the jumbo rate we are quoting our borrowers is about 2.75%. And both rates are deeply negative from a “Real Rate” perspective.
The Real Rate = The Note/Mortgage Rate – The Inflation Rate.
Hence, if a borrower gets a mortgage with a 3.5% Note Rate right now, her “Real Rate” is actually NEGATIVE 3.5%, give or take.
In other words, lenders and investors are willing to LOSE 3.5% against their money (because of inflation) right now every time they buy or hold a mortgage.
I don’t think there has ever been a time in history when “Real Mortgage Rates” were negative, let alone 3.5% negative.
This has been particularly the case over the last ten years, despite the very low rates, given the complete lack of inflation.
Anyway – 2022’s 3.5% rates in the face of inflation are far more of a gift than 2020’s 2.75% rates were because there was minimal inflation in 2020.
Borrowers are effectively getting compensated to borrow money, and that really is a gift.
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