interest rate

Low Interest Rates Do Not Make Homes Affordable

David Ning — Wed, 04 Aug 2010 17:00:31 +0000

Does the sales price of your home matter if the mortgage rate is low enough?

If you ever thought about buying a home, the recent all-time low mortgage rates must be enticing. And this is exactly how the government wants everybody to feel, by the way. In an effort to keep homes affordable (as they claim), the federal reserve is driving down interest rates to record lows. But is what they are doing helping? Let's take a look.

Just a short couple of years ago, interest rates were at 6 percent. For a $300,000 mortgage, the payment would have been $1798.65 a month. With the interest rate at 4.5 percent, the monthly payment drops to $1520.06. So far so good, because it costs us less to own our home.

But wait a minute.

Most people don't just refinance and lower their payment. These days, with rates at 4.5 percent, roughly the same monthly payment ($1798.73, to be exact) could get you a $355,000 mortgage. So what do people do? Instead of buying a $350,000 home with their down payment and loan approval letter, they shop for a $400,000 home. And who can blame them? An extra $50,000 almost always gets them a nicer place. Sometimes, it would actually allow them to pay more for a house than they otherwise would.

For example, they might have been able to get the house for $350,000 if they tell the seller that the offer is all they are approved for, but if a buyer can muster up $400,000, he might end up offering $360,000. Same house, higher transaction price. Having a lower interest rate also allows more people to qualify for a home. This is a good thing for someone who couldn't afford the payment before, but it drives prices higher because of more demand, ultimately lowering affordability for everybody.

In other words, lowering interest rates gets more people thinking about buying a home and drives up demand. Most of the time, that's a noble and worthwhile goal, since home ownership is still a dream of many. But as you've witnessed in the last decade, allowing more people to own homes mindlessly is just reckless. What we really need to do is make homes affordable so financially responsible people can actually afford the payments, which is only achievable through lower home prices.

I'm a homeowner too, so the selfish side of me is thinking that high-priced homes are good. But for the economy to grow and our country to be a place people want to be in the future, nice homes need to be affordable without government intervention. Unaffordable home prices will never get us there. Please allow homes to be affordable again for the hard-working American.

Related articles from MoneyNing:

How to Recast Your Mortgage
First Time Home Buyer Tips and Guide

This article is from David Ning of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Five alternatives to 0% yield U.S. treasuries

Xin Lu — Fri, 12 Dec 2008 01:10:37 +0000

This week the 4 week T-bill rate was driven down to 0% and the demand for these treasuries was astounding. It seems that investors are so pessimistic that they are willing to accept no yield for the safety of their principal. If you have been following the markets for the last few months it does seem like every other asset is falling. So, where could we put our cash if we do not want 0% yield treasuries?

1. I-Bonds - If you believe in the safety of treasuries, then you should have the same faith in I-Bonds because they are also issued by the United States Government.The current fixed rate is 0.7% and semi-annual inflation rate is 2.46% so the composite rate is 5.64% for at least six months.

2. Certificates of deposit- Practically all banks are still offering certificates of deposit with yields higher than 0%. The Fatwallet forums maintains a good list of the current rates at various institutions.

3. Checking/savings account - Most checking accounts do not pay interest, but your money is free for use. Many online and offline savings accounts are still paying decent yields above 2% and they are FDIC insured up to $250,000 per account.

4. Pay off debt - Instead of buying 0% treasuries, it would definitely be better to reduce any debt you have with any extra money you have. If you keep your money in an investment that pays nothing but your debt rises at a positive interest rate, then you will be able to pay less debt in the future with the money you have now.

5. Bury it - You may laugh at this one, but some people are dead serious about making their own treasure maps and burying their money. This may not be a bad idea in case there is some true catastrophe and there is no way to reach your financial institutions, but then again, someone could find your stash and dig it up.

I am sure that you can think of many other places to stash your cash amidst this very pessimistic investing season. Giving an interest free loan to the United States government may be seen as patriotic, but it is definitely not your only safe bet.

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

I Bond rates go to zero

Philip Brewer — Fri, 02 May 2008 14:47:57 +0000

Since 1998, the US Treasury has had a pretty good deal for small savers who were worried about inflation--the Series I Savings Bond. The interest it paid was based on inflation plus an additional return that was set by the Treasury and fixed for the life of the bond. On May 1st the Treasury announced the value of that fixed return for the next six months: Zero.

In two recent posts both I (in Savers suffering as rates fall--what to do) and Xin Liu (in A Simple Guide to Series I Savings Bonds (I-Bonds)) praised the return on the I Bond that was available through the end of last month. The fixed part of the return was just 1.2%, but added to the inflation rate, it was quite competitive with other rates that savers could get.

Even with a zero fixed rate, inflation is high enough that the composite rate comes in at 4.84%. (That's the annual rate you'll earn over the next six months if you buy a bond this month.) If you think inflation is going to stay high and other interest rates available to savers will stay low, then the I Bond is still a good deal--it's tough to beat 4.84% on other secure, short-term savings vehicles. Even so, I think the savings bond is a loser at this rate.

If inflation comes back down, the inflation portion of this bond will shrink, reducing your yield. You can't cash the bond in during the first year, and if you cash it during the first 5 years, you pay a penalty of 3-month's interest. That makes the I Bond a loser if inflation comes down.

If inflation stays up, you have to figure that interest rates will eventually follow. So far, there have been plenty of investors willing to take interest rates that are below the inflation rate, but that's an unusual situation--an odd confluence of foreign investors with large amounts of dollars that they have to put somewhere, combined with the credit crisis making people so nervous that they're willing to accept low rates in exchange for safety. I don't think that will persist, though--and in any scenario where interest rates move up above inflation, the I Bond is a loser again.

The only scenario where the I Bond is a winner is if inflation stays up but interest rates stay down. That's been true for months now, and it's always possible that it'll continue to be true. If it stays true for a year or more, then the I Bond will be a winner. To my mind, though, that's not the way to bet.

This is the culmination of a tend that's run throughout the Bush presidency. The last fixed rate set by the Clinton Treasury (in November of 2000) was 3.4%, and at that time the inflation part of the rate was just 1.52%. Under Bush, the inflation part of the rate has risen substantially, and the fixed part has shrunk to zero. Giving the small saver a good rate is simply not a priority for the Bush Treasury.

If you've got an old I Bond, bought when the fixed rate was higher, be sure to hang on to it--you've got a sweet return locked in for a long, long time.

[Update 3 November 2008: There's now a new rate for the next six months: 0.7%.]

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How Do You Take Advantage of the Federal Interest Rate Cut?

Xin Lu — Thu, 24 Jan 2008 08:34:09 +0000

I just came back from a company retreat without internet and I found out that the Fed has cut the interest rate by 0.75%! This is the largest cut since the one percent cut in 1982 and it did manage to boost the sagging stock market. So how can you as a consumer take advantage of this development?

1. Consider a Mortgage Refinance - Getting a refinance is only beneficial if your home's value is above the amount of debt you have outstanding and you stand to save a lot of money after paying the fees on the refinance process. The last time the Fed cut the rates drastically in the first half of 2001 my parents were able to refinance their mortgage from 30 years to 15 years and reduced the rate by more than 2%. That move saved them tens of thousands of dollars over the years. However, long term mortgage rates do not track Fed interest rates directly so most likely they will not go down by 0.75%. If you have very good credit and an adjustable rate mortgage it is also be a good idea to lock down a fixed rate that is low.

2. Lock in a Low Rate for a Large Purchase - If you need to finance a large purchase such as a car or a house this rate cut is very beneficial to you because the rate the lenders charge most likely will fall a bit. The caveat is that you do need excellent credit because lending guidelines have tightened lately. However, this is no excuse to go out and buy a new car you do not need just because you can borrow more money at a lower rate!

3. Save Money on Your HELOC - If you do have a home equity line of credit your borrowing rates will come down because it is closely tied to the prime rate (3% above the Fed's interest rate). This means that if you did borrow from your HELOC you would have an easier time paying it back. This is a good opportunity to reduce debt because even if you pay the same amount as before more of your payment will be applied to the principal.

4. Cut Down Your Credit Card Debt - Credit cards generally have very high rates, but most of them do track the prime rate which is tied to Fed rate. So it is possible that banks will reduce the interest rate they charge consumers. Once again, this is a great window to reduce your debt without paying extra money. You can also request an interest rate reduction or shop around for a card with a lower rate because banks are probably more willing to take a rate cut.

5. Start a Business with Loans - The cut is good news for those who borrow money for their business because the money their business spends on interest will be reduced. So if you want to start a business and need to borrow startup cash then this is a good time to do it. The Fed's hope is that more people will inject money into their businesses and create more jobs.

Many people believe that the Fed will cut the rates again in their meeting at the end of this month, so it will be even cheaper for people to borrow in the very near future. This is not exactly great news for savers like me because a cut in the interest rate means higher inflation and a lower yield on my money market funds. However, this is a great time for those who have debt to reduce what they owe and for businesses ideas to flourish.

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: