A Home Is Your Castle Against Rising Inflation
Mortgage rates are up to 5%, and some fear a valuation bubble. Even so, it’s a good time to buy.
By Laurence Kotlikoff
Wall Street Journal, April 18, 2022 2:21 pm ET
I published this op ed in the WSJ in April. Making it available to everyone per their permission. Clearly, the data cited in the column are out of date. Inflation over the past year ran at 8.6 percent — a forty-year high. It will likely stay high for quite a while. But 30-year mortgage rates are 5.58 percent as I type. If inflation stays high, you’ll be able to pay back much of a new mortgage in watered down dollars. Short-term real interest rates remain negative and medium and longer-term real interest rates are very low. Hence, interest rates, properly assessed, are not high. This is one of several reasons I don’t foresee a recession. But lots of people are now talking up that possibility and they may succeed in talking the economy into a downturn as I discussed in this Forbes column, which I’ll make available to everyone tomorrow.
Mortgage interest rates have been rising at their fastest pace in years. Last April, the 30-year fixed mortgage rate was 3.2%. Today it’s 5%, the highest in more than a decade. “We’ve never seen a time where mortgage rates have risen as quickly as they have and the market hasn’t cooled off,” real-estate economist Ralph McLaughlin told the Journal. “I don’t expect the market to collapse, by any means, but certainly it’s going to go from a gangbuster market to one that hopefully looks more normal.”
But if you’re holding back from buying a house because of the rise in rates, consider that inflation is up even more. A year ago it was running at 2.6% on a year-over-year basis (March 2020 through March 2021). Today, this retrospective annual inflation measure is 8.5%. We haven’t seen inflation this high since the early 1980s. If inflation continues at this rate, you’re better off borrowing money today at 5% and paying it back a year from now with dollars that have depreciated by 8.5%.
But the story is more complicated. Retrospective inflation isn’t the same as prospective inflation. Prices rose by 1.2% last month alone. That’s an annualized inflation rate of 15.4%. In that case, the current 5% mortgage rate is even more of a bargain in the short term.
The market isn’t banking on 15.4% inflation over this year, let alone the next 30 years. The one-year Treasury bill rate is 1.7%. The one-year inflation-indexed Treasury bill is negative 3.2%. Hence, the market is figuring inflation at 4.9% (1.7% plus 3.2%) over the year. That’s still less than the prevailing 5% nominal mortgage interest rate, meaning that at least in the first year a 30-year mortgage costs nothing after inflation. If the market’s wrong and inflation runs for the next 12 months at last month’s pace, you’ll make a substantial real return on your mortgage.
To be sure, 30 years is a long time. Inflation could quickly drop and stay low for decades. The market forecasts only 2.6% inflation over the next 30 years, according to the difference between the 30-year nominal and inflation-indexed Treasury yields. A 2.4-point spread between the mortgage and inflation rates still makes the former incredibly low. The projected real mortgage rate is still close to its three-decade low, a period that includes many years of inflation far lower than today’s. And the nominal 30-year mortgage rate of 5% is far below the typical value going back half a century.
Given all this, should you buy now or worry that if you do, house prices will crash? Buy now. Houses, like most physical assets, retain their real value during high inflation and have done far better than most such assets. Plus, if you buy a primary residence now and home prices fall, you won’t be affected unless you need to sell. As long as you have a stable job, can manage your mortgage, and don’t need to move anytime soon, a short-term drop in housing prices isn’t a concern.
As for inflation coming down, don’t count on it. Wall Street has a terrific track record of misjudging inflation and asset prices. If it didn’t, we would see bond and stock prices routinely crash and soar. The good news is that if inflation drops as predicted, interest rates on fixed-rate mortgages will likely decline as well. This means you should be able to refinance your 5% mortgage at a lower rate and monthly payment. If inflation exceeds expectations, you’ll be ahead of the game.
Why might inflation stay high? First, supply-chain bottlenecks may continue, particularly because of current and likely future Covid shutdowns of major parts of the Chinese economy. Second, the European Union may join the U.S. in expanding the embargo against Russian energy. This would push fuel prices even higher. Third, countries that can’t pay their bills make money by making money. The Fed has been printing (electronically creating) a vast quantity of money for decades. Much of this new money has been used to purchase private financial assets, which the Fed can sell back to the market. But a massive amount has been used to pay for government spending. The prospect of more monetary finance is crystal clear from the Congressional Budget Office’s projections of the wide and rapidly accelerating gap between federal spending and taxes.
The government is, in short, broke and resorting to the printing press rather than politically painful fiscal discipline. That portends more inflation, against which a home provides excellent protection.
Laurence Kotlikoff is a Boston University Economist, a NY Times Best Selling Author, President of maxifi.com, and Author of Money Magic.
Your analysis describes exactly how my wife and I benefited during the high-inflation, high interest rate environment in the early 1980’s. We got our house at a relatively low price in 1983 with a mortgage at 12-3/4 % rate. The low price was because of various factors, one of which was high interest rates. Within 8-10 years, we’d refinanced the rate down to 8-1/4 % for 15 years. (Unlike a high purchase price, which can’t be renegotiated, the high interest rate can be lowered through refinancing.) So in 2007, we paid off the mortgage and have lived practically cost-free since then. Of course, utilities, maintenance and insurance costs continue.
Larry is certainly correct when he reminds readers that mortgage rates are currently negative after inflation and home prices have historically kept up with inflation over the long-run. These conditions, all else equal, may make buying and maintaining a home a good "investment" and hedge against inflation. That said, buying and maintaining a home that is too expensive given your lifetime resources is NOT going to protect you against long-run inflation--it's going to do the opposite! Remember, operating costs for your home, including taxes, insurance and maintenance, will keep pace with or outpace inflation over time. So, yes, with inflation as high as it is today, short-term borrowing costs are certainly favorable. But, when it comes to buying a home, the most important thing is not interest rates but rather knowing what is affordable and not overextending. Here's more on the subject: https://lyonfp.com/blog/how-much-house-can-you-afford