Multidecade Mortgages Are Dumb, and Here Is Why
A lot of people have been sharing a version of this tweet, some of them (financial people) focusing on the home price appreciation and others (housing advocates) focusing on the lack of housing inventory.
The CPI report underscores how crazy the housing market is right now. In "normal" times, rising rates would temper home sales & prices. But given the dearth of inventory (white line), decent homes that do come to market are scooped up ASAP, helping push prices higher (blue line) pic.twitter.com/4cSaGVrbt1
— Robert Burgess (@BobOnMarkets) April 10, 2024
The insight in this tweet isn’t about home values or a lack of inventory but the feedback loop between the two as it relates to interest rates.
There is a widely held belief among investors that high interest rates will crash housing markets. Well, we have higher interest rates (still historically low, but higher than zero), and home prices have only gone up.
There is a widely held belief among housing advocates that higher interest rates make it more difficult for people to purchase homes, while lower rates give people more purchasing power and allow them to, in a sense, stretch their monthly payments into a larger mortgage. Again, rising prices should undermine this belief.
What should be dawning on everyone (where this is not already abundantly clear) is that there is a high cost for manipulating financial markets. Having zero interest rates is not a natural condition; people don’t naturally lend money when they know it will lose value. They especially don’t do this over a long period of time, like decades—like a mortgage.
In Escaping the Housing Trap: The Strong Towns Response to the Housing Crisis, I wrote about how Zero Interest Rates Policy (ZIRP) distorts financial gravity. It was a policy choice designed to create more lending, especially home loans, and it worked.
And now, with interest rates going up (the only place they could go from zero), we’re stuck. That is because, as I wrote in the book, “long-term mortgages are absurd as an investment vehicle.” The only way they work is if interest rates don’t move. That’s an absurd assumption, especially over multiple decades.
When interest rates fall, the investment value of a 30-year fixed rate mortgage goes up. Someone owning a bundle of mortgages paying 6% annually will want to hang onto them when new mortgages are being made at 3%. Yet, those are the exact conditions that prompt the borrower to refinance, terminating their 6% payment in exchange for a lower-yielding loan. The investor has no recourse but to give up their prized asset.
The opposite happens when interest rates rise. Someone owning a bundle of mortgages paying 3% annually will want to trade them out when new mortgages are being bundled at 6%. That is exactly when homeowners hunker down. Few people who committed to paying a 30-year mortgage at 3% seek to refinance when rates go to 6%. Again, the investor is stuck, this time with lower-yielding paper.
Said differently, my wife and I have a mortgage at 3.375%. If we were to move, selling our home and buying something new would put us in the position of paying much higher interest on our next mortgage (our dollar would not go nearly as far). We’re not going to do that unless we are forced to by circumstance or our financial condition radically changes. Thus it is with most Americans.
This is what it means to be trapped. Rising interest rates. Rising prices. Lower inventory.
Investors get stuck holding on to low-performing mortgage notes while property owners are stuck with fewer options and potential buyers are squeezed because of a lack of inventory. Let’s understand what this is: the consequence of a decade of zero interest rates.
Despite what economists might claim, financial manipulation is never cost free.
Mortgages are at the foundation of our financial system, yet they are the worst kind of investment. Investors accept bad payoff asymmetry because the federal government is committed to keeping housing prices elevated. Investors buy mortgages because mortgages are a safe bet.
And that is why, as I wrote in the book and have said here before, it is only a matter of time before the next financial product becomes the industry norm: the 50-year mortgage.
While demographic trends suggest there will be upward pressure on wages over the coming decade or more, there remains a massive affordability gap for the next generation of homebuyers. The 50-year mortgage, fully backed by the federal government and financed through Wall Street investment banks, will lower monthly payments enough to allow desperate Americans in their 20s and 30s to buy homes from desperate Americans in their 70s and 80s, all while keeping prices elevated and the financial sector secure.
This is a horrible outcome — bad for just about everyone — but this is the kind of thing a society does when it is trapped. There is a way out.
To learn how you can escape this broken system of financial manipulation, pre-order your copy of Escaping the Housing Trap: The Strong Towns Response to the Housing Crisis, releasing tomorrow.
Charles Marohn—known as “Chuck” to friends and colleagues—is the founder and president of Strong Towns. He is a land use planner and civil engineer with decades of experience. He holds a bachelor’s degree in civil engineering and a Master of Urban and Regional Planning, both from the University of Minnesota.
Marohn is the author of Strong Towns: A Bottom-Up Revolution to Rebuild American Prosperity (Wiley, 2019) and Confessions of a Recovering Engineer: Transportation for a Strong Town (Wiley 2021). He hosts the Strong Towns Podcast and is a primary writer for Strong Towns’ web content. He has presented Strong Towns concepts in hundreds of cities and towns across North America.