By Somnath Banerjee
Normally, when monetary policy rates go up, that is bad for property prices. But then I am sure you assumed there would be a “but” coming very soon as else I won’t mention it. We are not living under normal economic environment, so why should standard rules of economics apply to housing market.
Policy rates everywhere in the world has moved rapidly up (5.25% in the US, 4% in Europe, 5.25% in the UK and likewise globally). It’s natural to assume mortgages (like any other loans) will get pricier and it indeed did. Mortgage rates in the US are now more than 7.4% (for a 30-year mortgage).
But house prices after falling c.5% last year are on their way up again. It’s immensely counter intuitive. Why did house prices fell first and why is it going up now? The reason it fell was because as mortgage rates were going up, demand fell. No curve balls there.
But why are they rising again when mortgage rates are still high? The demand is probably subdued even now but what happened is supply fell even more than demand. This fall in supply overcompensated for fall in demand. I want to talk more about this fall in supply.
Why did landlords started taking their properties off the market?
Typically, one would assume that if someone sells one’s house, one would be looking to buy another place to live. Imagine a house owner having bought a property five years ago for €1 million. Let’s assume she bought it with a down payment of 20% (€200k) and mortgage rate of 3%. I won’t do the exact math but let’s assume she has paid back 20% of the principle (€160k) implying she has €640k worth of mortgage left to be paid (remember, at 3% for say another twenty-five years).
Let’s assume she can sell it for €1.3 million (a 30% appreciation). She has a nice positive equity of €300k and is sitting on a nice pot of cash of €660k that can be used to pay out deposit of say 44% on a €1.5 million dream house she likes and looking to move into.
She should do it, right? Not so fast. Its where the mortgage rate comes into play. She would have to take a mortgage of €840k at a rate of say 6% on her dream house. Suddenly, it’s a deal breaker despite the nice positive equity that can be realised and the chance of an upgrade.
A 3% interest only mortgage on remaining €640k mortgage would mean interest of €1,600 per month, which simply shoots up to €4,200 per month with a 6% interest rate on €840k mortgage. The keen eyed might have noticed that I am not even talking about amortisation of the principle here (that would make it even costlier).
You can see why supply is falling apart. She along with other landlords would not look to move whilst mortgage rates are so high. Supply went down faster than demand. Conundrum solved.
Now I come to Assumable mortgages. A mortgage is considered “Assumable” if the loan agreement allows the original borrower to transfer their loan to someone else. In this case, the buyer of the home would simply take over the seller's existing loan, and the current rate, terms and balance would stay the same.
Imagine the same landlord who we discussed above finds that the dream house she wants to buy is on an Assumable Mortgage of 3% or there abouts. Walla!! Problem solved. She can upgrade to her new house and keep her monthly instalments in line with what she was paying before (not exactly as the mortgage value has gone up from €640k to €840k but you get the idea).
I am to believe Assumable Mortgages are more prevalent in the US then Europe but one thing is for sure, no bank will tell you if you have an Assumable mortgage. Read the fine print. If required call your bank and check.
Sure, they would stall you and give you hard time to the extent that you may feel like giving up, but don’t. Pursue. Banks have to honour that agreement (if it’s there) with a minimal fee and of course credit checks etc. on the new owner.
Pop Quiz: The US policy rate is at 5.5%. Where do you see that on the new year’s eve? Send your magic numbers to sbanerjee@curmiandpartners.com with any reasons that you may have including if it was your parrot that picked the numbers.
Disclaimer
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.