Inflation, part 1: On shelter futures
jbconsulting.substack.com
jbconsulting.substack.com
So it doesn’t cause me any anxiety.
Regarding the upside, the rates aren’t much different in the US where you typically have 30 years locked in. Unlike Canada, these also generally have no prepayment penalty, so you can always refinance on rate drops. I’m quite sure the rates on a ARM 5 year or 8 year would be directly comparable to a Canadian mortgage (and you always have that option in the US).
There’s lots of great things about Canada, but I think you’re really stretching to see a positive where there isn’t one. (I’m Canadian but I definitely don’t hold a positive view of our financial institutions.)
They're don't really come from the lending industry - lenders could not and would not ever create this product on their own.
They're a government subsidy to mortgagors enabled by the origination process, obscured by a few hops of financialization.
You get a rate guarantee for 30 years plus you can refi, sell or walk away if the bet doesn't go your way. It's pretty much begging to be exploited.
I was going to quibble with this since I’ve seen fixed rate mortgages in Ireland but…
> A fixed rate mortgage is a home loan for which the interest rate is kept the same for an agreed amount of time. The maximum length of time for which a mortgage can be fixed in Ireland is ten years.
https://personalbanking.bankofireland.com/articles/my-first-...
The fact that "cheap" 30 year fixed rate mortgages only exist in a few countries (US is only one I know of, but it's a big world) is the most accessible evidence that they're created by government policy (without having to dig into the technical details of how they are originated and guaranteed).
(without having done it, I think I don't like the idea of 1/2!)
You can argue +'s and -'s, but you can't argue it's free market rates.
Without being able to itemize, it might make more sense to pay the principal down, but my interest rate is low enough that I have to think if there is something better to do with extra money (we are already over exposed to the stock market). Also, Trump’s tax cuts for individuals will expire soon, so the bigger standardize deduction might go away with it.
And they work; arguably these are one of the reasons why "owning your own home" was able to be something that so many Americans see(saw?) as an unquestionable part of adult life. The government used its political power to make things easier for a huge subset of its less-well-off citizens.
> It's pretty much begging to be exploited.
And yet it mostly isn't. There hasn't been any huge crash or people getting filthy rich due to the recipients of 30 year mortgages exploiting the system in any way, and recipients are the ones that would be doing the exploiting in the context of your comment. The lenders of course caused 2008, etc, but they're arguably the ones who would hypothetically be exploited.
If it were actually begging to be exploited, I would suspect that we would see something different than this.
Policies to encourage construction directly would work better to increase home ownership than subsidizing mortgages.
Unfortunately, the existing home owners, directly or indirectly, would lobby local gov't/councils to stop new builds. Current zoning laws also don't help.
Those very US government programs that implement the political guarantee also implement an exploit in oh, so many programs for non-owner occupants, typically realtors / agents, to leverage in ways they absolutely cannot in a truly open commercial market. Every single realtor / agent acquaintance I've been introduced to will wax on about their impressive portfolio holdings if I give them an opening to do so.
Acting innocent, I inquire about the details of their fabulous business acumen. Every single one below the $20M valuation mark, without exception, and most cluster around the $1M valuation mark, hold the bulk of their assets via government or quasi-government-backed paper and not through a commercial bank loan.
The US rules around establishing owner occupancy in many programs are insanely easy to circumvent, and for all practical purposes never enforced. There are plenty of people exploiting the program making a pretty penny off of taxpayer largesse. Real estate is one of the most heavily subsidized assets in the US.
The US and Canadian homeownership rates are almost identical (around 66%). I don’t think the US’s mortgage subsidies significantly impact homeownership rates.
> And they work; arguably these are one of the reasons why "owning your own home" was able to be something that so many Americans see(saw?) as an unquestionable part of adult life.
The ownership rate for Americans (mostly 30y terms) and Canadians (usually 1-5y terms) is basically the same at around 65%.
* https://www.statista.com/statistics/184902/homeownership-rat...
Is the government buying the mortgages or how is this a subsidy from the government? It seemed from the great financial crisis that these mortgage backed securities were being bought by institutions all over the place, so if there is demand why would it be a subsidy?
US mortgages are certainly subsidised by the taxpayer through some complex financial instruments and those two government owned corporations.
Funnily enough when I jest to American colleagues about it being socialism they seem confused and don't think that it is at all.
Many don't seem to realise just how drastic a 30 year fixed term is in every other financial market on Earth. I think the max you can fix in Australia is 3 years?
The term mortgages to me make it a bit closer to variable rates. The rate gets updated every few years. Banks themselves to fund the mortgages don’t get 25 year loans. So as an institution they need to set rates based on risk so they don’t lose money. This risk increases the further you project into the future. So all other things being equal you are not paying a premium to insure against that risk.
I’m not commenting on the financial institutions as a whole, or other factors that may lead to higher or lower rates. I’m under the impression that rates are a higher in the us for the 25 year mortgages when calculated off of the overnight rates from the central banks. But I don’t have any data handy to back up the impression for I could be wrong.
I suppose having this be an option for the consumer is probably the best option. But for most consumers insuring against rate increases will be quite costly.
I’m not sure how you can make an argument that long and specific while completely ignoring the evidence to the south of you that contradicts it.
When rates are going down, yes.
But locking in low rates in the United States for 30 years either at purchase time or via refinancing is one of the weirdest advantages of home ownership here. It's surreal to have a 2.x% mortgage locked in for decades when rates are quickly going up and inflation is reducing the relative value of my debt and payments.
the asset price could remain stable, if the jobs that service those mortgages aren't removed.
Inflation of consumables can be controlled, but it is painful. Inflation of assets should not be controlled, even if it could - asset growth represents the wealth of those who invested in it. If this growth is artificially suppressed, millions would lose their retirement funds, and become poorer in the future, and for what?
The US 30 year fixed bottomed out at 2-2.5%, which seems about the same as the lowest 5 year fixed in Canada?
When Canadians have to renew at 5-7% in a few years that’s going to cause massive havoc.
But you can lock in a fixed rate that will be lower than a variable rate in the future when rates rise.
A huge number of Canadians will not be able to afford their mortgage payments over the next 5 years because they did not calculate rate rises when buying home. Furthermore, they won’t be able to sell the home without taking a huge loss because housing prices will have plummeted due to rate hikes.
Combine that with rising cost of food and gas, Canadians are in for a wild ride.
I expect a massive crash in the Canadian home market. In certain areas that have been high fliers I’d expect 50% - 60% declines or larger. Combine exploding interest rates, high inflation, and banning foreign buyers, the housing market is about to get “cheap” for cash buyers.
For most, it’s been more or less working out fine for some time, thus far.
That felt super weird for me coming from France where flexible mortgage rates do not exist.
But of course everybody was getting 1% last year, and now it's 1.5% and everybody already feels the difference. If it had to go up to 4% the whole country would be in crisis, and above that well...
(I personally think they should test for even higher rates – I'm terrified to see how many people are in absolute shock that rates are rising rapidly, after being told that exactly that will happen for years)
So the banks may well say "if you spend a minimum on food and clothing, and nothing on anything else, you can afford to pay high rates." But that's not what regular people would mean by affording it.
In denmark fixed rate mortgages are still the most common. I have a 30 years fixed rate (at 1%) mortgage, that I can pay out at any time (at end of any given quarter).
Flex rate mortgages are somewhat popular in good times, but they are renegotiated every year or every five years. There was a period where the one year rate loans had negative interest rates.
And yes, this is absolutely terrible public policy; forcing Canadians to take a series of short-term mortgages not only makes the economy far more vulnerable to interest rate shocks, but also creates a significant dead weight loss as homeowners and banks repeatedly churn through mortgage application and initiation paperwork.
The non-confirming loan share varies widely over time, but is usually double-digit percentage of overall mortgages.
https://www.integritylending.com/understanding-what-a-federa...
Doesn't that just mean that the government gives home owners free put options?
Yet another instance of welfare for the well-off?
The real issue is the prices having gone up so high to begin with.
But I don’t see a justification for fixing housing prices. If we assume that a decent fraction of people have maximally extended themselves to buy their homes, then when forced to remortgage at a higher rate those people would instead sell and downsize, rent, move in with family, etc. A model which allows demand to change as a function of monthly mortgage cost could yield completely different dynamics.
That said, awesome analysis. It was really interesting to learn that home price increases and interest rate decreases have basically perfectly balanced each other to keep mortgage payments flat. And we’ve just run out of interest rate decreases…
If you want to stop long term inflation you actually need 0% interest rates or lower for 0% inflation like Japan.
> But I don’t see a justification for fixing housing prices.
There is no justification for fixing house prices; that is an assumption made purely to consider the result of that hypothetical scenario, to examine what the consequence would be of housing prices not falling. The reason this scenario is worth modelling is simply because many Canadians do strongly believe that housing prices will not fall, so I want to examine what the world would look like with this belief being correct.
I also consider a scenario where housing prices drop by half. If rates keep going up as quickly as they are, I actually think it's plausible that housing prices drop more than this, but I have to pick a number that won't cause readers to simply tune out.
The model so far is only a partial model; housing demand is not included, but it could be in the future. Then housing prices would not need to be taken as an input, and could be projected forward. But I'm not sure it's worth the time to build that model; no matter how rigorously I derived it, I don't think it would change anybody's minds. Canadian housing prices are a charged topic and the beliefs people hold are pretty hard to change.
I haven't read your first article yet so I'll pipe down for now. I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup!
The way that money works is a fascinating subject. I note that there are far more articles about making money work via investments etc rather than from direct work from the US and CA than pretty much anywhere else. I suppose that's the "dream" thing.
Thank you! That's a good point. I'm not sure how to handle it because exchange rates do fluctuate on the scale of decades that my post covers. For example in 2012, the CAD and USD were at par (1 USD = 1 CAD), whereas last year we were down as low as US 0.70 per CAD. If I expressed the Canadian CPI in USD that would look like a 30% deflation. Now we're up at 0.79 USD per CAD one year later. It's pretty volatile.
> I note that the graphics of a biplane looks suspiciously like a German WW1 aircraft - the tailfin shape is certainly not a Sopwith Camel or Pup!
You are (almost) correct! It's a Fokker D.VIII monoplane. I'm not a spy! I was just looking for a nice clean public domain vector art image of a prop plane in profile on Wikimedia Commons and that's what I found first. Honest!
If you wanted to convert the numbers, over decadal timescales you'd probably want to use purchasing power parity (PPP, or $INT) figures. That tends to be less volatile, and since it reflects the approximate cost of goods and services it's a better intuitive like-for-like match.
> I was just looking for a nice clean public domain vector art image of a prop plane
Given the topic, I'm a bit disappointed you couldn't get an image of a Japanese Zero.
Incidentally, if you're still working on "Inflation, part 2", one way to close the central bank reaction function is to assume a Taylor Rule (https://en.wikipedia.org/wiki/Taylor_rule). I've long thought that the Taylor Rule should be interpreted as a kind of PID controller, save that nobody in economics seems to relate the "assumed equilibrium real interest rate" to an integral term.
Brilliant. I could have made the confusion so much worse.
> I've long thought that the Taylor Rule should be interpreted as a kind of PID controller...
Yes, this exactly. I'm writing a part 2 from exactly that perspective, and I also want to examine how forward guidance reduces phase margin. But there are a few more concepts I have to lay the groundwork for beforehand, especially how to model forward-looking expectations. It might not be ready particularly soon... I wasn't expecting so much attention so quickly!
My eyes are dim, my back is grey etc! Of course it is - I made a model of it about forty years ago and obviously a 1/32 scale Fokker DRI too, painted red with a white nacelle. My parents were stationed in West Germany for about 10 years on and off. The world was quite odd in the 1980s as it is now.
Now as to scaling currencies. I'm a bit ambivalent here. I think a rule of thumb might be better than nothing so 4DM == £1! No, as you say it is too volatile for that. I can remember the days when there were at least two USD to the GBP and the Euro wasn't invented. The NLG (Dutch Guilder) was roughly like a DM (Deutsche Mark) but not quite: the Dutch currency was extremely colourful and way prettier than other currencies. France had their Franc - 10 to the quid (GBP) which was easy to convert, and so on.
If I want to scale your currency to mine or another then I think that is my problem, now I've had a think about it.
This is the followup article heavily discussed in that thread.
I didn’t realize until reading the footnotes, but this is largely because in Canada you cannot get a fixed rate mortgage, only a 5 year ARM. So nearly everyone who has a mortgage will be forced to refinance at higher rates over the next five years, and those higher rates will greatly increase their cost of housing.
It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.
The bank's plan is that they will sell the mortgage before the paint drys; then they don't care what happens. Regardless, the expectation is that your mother will continue making payments until either she or her estate sell the house, at which point the full balance of the loan will be repayed without any early payment penalty.
Nobody thinks an 80yo will live another 30 years btw. Queen Elizabeth is 96 but her chances of writing herself a letter are actually not even half, since annual attrition at that age is something like 20 or 30 percent. Sorry to be a downer, I don't mean to be cynical about your mom, just looking at statistics.
The bank is taking a risk though, even if they did get recover with the estate, that's got to be a pain in the ass. I wonder at what point the administrative cost of getting that house resold doesn't make sense.
And it turns out that Fannie and Freddie will not back loans that involve balloon payments. Banks want to make loans that Fannie and Freddie will back, because that basically takes away all their risk. To figure out why this is a problem for shorter loan terms, we have to look at monthly mortgage payments. Here's what US fixed mortgages look like right now (quick glance at bankrate.com), with monthly payments assuming you're taking a $500k loan:
Term Rate Payment
30Y 5.54% $2850
15Y 4.75% $3890
10Y 4.67% $5220
1. As the term drops, the interest rate does not drop proportionally. 30Y -> 15Y is a 50% drop in term, but only a 14% drop in interest rate. 15Y -> 10Y is a 33% drop in term, but only a tiny 1.6% drop in interest rate.
2. Look at how those monthly payments go up! And we've only gone down to a 10Y term, whereas, from what I understand, Canada's look more like 5Y. So even if we're "generous", and say that going from 10Y to 5Y gives you an interest rate of 4.25%, your monthly payment goes up to around $9260! How many people in the US could afford a $9k monthly mortgage payment on a $625k home (assuming 20% down payment, which is standard in the US)?
Canada solves this with a balloon payment. If you're Canadian I assume you know this already, but for everyone else: essentially, for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above. And then, near the end of the loan term, you make up for it with a giant "balloon" payment. Americans are conditioned to think this is scary, but in practice, what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term. (I've gotten this from a random discussion on HN, not my own research, so please correct me if I've gotten anything wrong here.)
And, as I said, this can't work in the US because Fannie and Freddie won't back loans that include balloon payments, so banks don't generally offer them. Many do offer 15Y and 10Y fixed-rate mortgages, but they have much higher monthly payments, so most borrowers stick with the 30Y mortgage, especially when interest rates are at their lowest, like they have been for the past decade+.
The alternative in the US is the adjustable-rate mortgage (ARM), usually offered as a 5/1 or 7/1. It's a 30-year mortgage where you get a fixed rate for 5 (or 7) years, and then your rate is adjusted to market rates every year for the next 25 (or 23) years. The interest rates are even lower; for example, the 5/1 ARM is at 3.91% right now, so the monthly payment ($2360 for our $500k loan) is lower than even the 30Y fixed. But many people view them as risky, and like the comfort in knowing that their interest rate will be locked in for 30 years, even if it's a little higher. Given that rates are going up now, though, I expect ARMs will become more popular, as people will predict/hope that rates will be lower in 5 (or 7) years, and they can refinance with a 30Y fixed -- or another ARM, if rates haven't gone down much, or, worse, have gone up.
This doesn't sound like a solution at all, just a way to prevent actual homeownership and assuring all your residents will be debtors and essentially, renting their domicile, for life.
I don't live in Canada, not sure if you are right or wrong, but your claim is the exact opposite of the OP:
what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term.
> or they refinance and start a new loan term
I guess that may be ambiguous depending on where you are from, but where I live, the normal interpretation of "refinancing a mortgage" is to get a new mortgage for the principal remaining on your old mortgage, and pay off the old one with it. The new mortgage is for a smaller loan amount than the old one.
Yes, some people do take the opportunity to cash out some of their existing equity, but I don't think that's the most common thing. So yes, you do eventually own the home outright.
if there's a huge balloon payment owed at the end, then the Canadian "homeowner" still owes a large amount after 25 or 30 years. So perhaps the next loan is for less, but still a significant amount. In the US, most people do complete their 30 year mortgage and the home really is paid off, although they continue to owe property tax.
> a Canadian mortgage, your monthly payment is much lower than the numbers calculated above.
...which is why Canadian real estate is insanely expensive, even worse than the US. Buyers think monthly payment. If you lower the monthly payment, by whatever means -- extending the life of the loan, reducing interest rates, deferring principal, etc -- prices will rise. If Canadian mortgages have artificially low interest rates due to short-term rate resets AND defer principal to a balloon payment at the end, it's no surprise that Vancouver, Toronto, etc have become entirely unaffordable.
There's no difference.
A (first-time) Canadian homebuyer will typically take out a mortgage with an effective 25y amortization term over a 5y locked-in rate. At the end of the 5y, the homeowner who doesn't move will typically "renew" their mortgage for a 20y amortization term at the then-prevailing 5y fixed rate. If rates remain constant, then their monthly payment will be essentially unchanged.
A (first-time) American homebuyer will typically take out a 30y fixed mortgage, with a 30y fixed rate and a 30y amortization period. At the end of 5 years, there is no paperwork to fill out but the mortgage will now have 25y left on its amortization, and the monthly payments will be unchanged.
The main difference is that the US mortgage has a great deal of optionality built-in. An American homeowner can typically prepay the mortgage at any time without penalty, and the most common reasons to do so are to move or to refinance when rates are lower. The Canadian homeowner typically faces a prepayment penalty if they try to refinance before the end of their term.
for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above
So how can a Canadian mortgage (or series of them in 5 year increments) be paid off in 30 years just like a US mortgage, if the monthly payments are much less each month?
When you presented your US numbers above, your "X year US mortgage" both fixed the interest rate for X years and set the amortization period as X years.
Canadian mortgages don't do that. Canadian mortgages fix the interest rate for X years, but the payments are set for a Y-year amortization schedule (Y>X).
If you go to a US banker and ask for a 5-year mortgage, they'll think you want your house paid off entirely at the end of 5 years, and you'll pay a hefty portion of the principal each month. If you walk into a Canadian bank with the same request, they'll be happy to quote you 5-year mortgages with an arbitrary amortization period in the 5-25 year range.
The risk for the Canadian borrower is that rates might go up significantly in 5 years, while the American lender is taking the risk that rates might go up significantly and they've got capital locked up at lower rates then what they could get.
The US has variable rate mortgages that are only fixed for, say, 5 years, but even when the minimum rate is capped just below the initial rate, they have only slightly lower initial rates than 30-year fixed rate mortgages , because while fixed rate mortgages price in interest rate risk, variable rate mortgages price in default risk (which is increased by the transfer of interest rate risk to the borrower.)
> For example, it looks like right now (just a quick Google, so maybe these are off) a 30y rate in the use is about 5.2%, while in Canada you'd be able to get around 3.9%
That's likely due to differences between Canadian and US markets other than the term for which rates are fixed, since 5/1 ARMs in the US, which aside from the interest rate lock are offered in a comparable market to US 30-year fixed mortgages, are currently at 5.04% national average.
Further, the OP made it sound like a lower monthly payment is a given. In fact, as you note, that's only true when rates are not rising. The OP (and lots of homeowners, apparently) is going to be in for a surprise as the most recent cohort of Canadian 5-year mortgages come due and get refinanced at current rates. Those payments will no longer be lower than the US equivalent who locked in a 30-year fixed rate between 2017-2021.
Thanks for the (much better) explanation.
I suspect you have a misunderstanding, presuming Canada is similar to New Zealand. In NZ, you get loan that you pay off the principal over a 25 or 30 year loan term. For the interest, you can be floating (variable interest rate) or you can lock in a fixed interest rate for a period which most people choose to be 1 or 2 years, but can be up to 5 years. Let’s say I have a 20% deposit and lock in for 5 years fixed interest[1] at 5.89%. After 5 years, the loan will revert to whatever the floating rate is in 5 years time, unless I sign up for a new fixed period interest rate (term interest up to five years, at whatever the fixed term interest rates are in 5 years). It is confusing if you come from the US because in NZ the mortgage loan term (say 30 years) is not connected to the fixed interest term (1 to 5 years) and new interest rates/terms are selected by the mortgagee whenever the previous interest term expires.
[1] https://www.westpac.co.nz/home-loans-mortgages/interest-rate...
For Canada, what I understand is that you have a 5Y (well, something between 1Y and 7Y) mortgage. The monthly payment makes it look like your amortization schedule is over 25 years, but after 5 years (or whatever 1 to 7), you'll often owe a big balloon payment, though most Canadian homeowners will end up either selling their home or refinancing at that point.
I think the closest thing to what you're talking about (in NZ) in the US is an adjustable-rate mortgage, usually offered as a "5/1" or "7/1", which means that you get a fixed rate for 5 (or 7) years, and then your rate is reset to the market rate every year thereafter (still for a total 30 year term). In practice, though, most people in the US who do ARMs choose them because they expect to sell their home in under 5 (or 7) years, or end up gambling that interest rates will be more favorable after the fixed-rate period, and can refinance with a 30-year fixed (or perhaps another 5/1 or 7/1 ARM) with a more-favorable rate.
In the USA there are statutory bodies that do that. In a free market there would be no liquidity.