The era of easy money is coming to an end thanks to a combination of geopolitical events that have spurred a wild rush of inflation. Central banks in many parts of the world are already beginning, or are set to begin, tightening cycles, designed to quash this inflation. The demand for housing has held up well keeping the housing markets from tipping over. But what will happen when higher mortgage interest rates set in? To find this out, we must first analyze the current situation more carefully and see what risks remain.
Recent Gains: Despite a huge surge in inflation, rising interest rates, and uncertainty in the debt markets in many parts of the rich world, house sales are nonetheless brisk. House prices in many places are sky high, up by twenty-six percent in Canada over the last two years. The average house in New Zealand could cost NZ$ 1 million ($640,000). In Australia property values have risen by more than twenty percent in a year. Property prices are supported by scarcity in housing supply, robust demand, higher levels of net household wealth, and strong labor markets. Better lending standards since the 2007/8 financial crash have further helped strengthen the housing markets.
Current Risks: What stands in the way could be rising interest rates that could make existing homeowner debt loads too difficult to manage via higher payments. If other debt instruments require prospective homeowners to pay more of their net disposable income for other purposes, it could soften housing demand. If the hit was big enough, the aggregate markets could see a fall in housing prices. Falling prices for houses could cause an equity loss for homeowners to deal with if they were forced to sell and move owing to job opportunities elsewhere. Further, cascading housing prices could drive the value of the property lower than the amount of the mortgage, placing the banks that hold the mortgages in a precarious position.
Aggregate Number of Mortgages Per Economy: The mortgage debt load problem varies from one country to another. In Scandinavia, there are a very high number of homeowners that have mortgages per total. In Norway and Sweden, mortgage loans for personal residences constitute about one third of all bank loans. In Denmark that ratio rises up to one half. This could put banks in a precarious situation if rising interest rates are followed by a recession that creates a cavalcade of defaults. In Australia and New Zealand, the property values have gone up so high even a modest increase in interest rates could cause the markets to seize up. However, in America and Britain, it might take an increase of about four percent to make the markets rattle. In Eastern Europe the percentage of mortgage-free home ownership is substantially higher than in Scandinavia. The same applies to Spain and Italy. In both areas land values were significantly cheaper enabling more families to get into house ownership without extensive debt. In Germany, people are more likely to rent their homes rather than borrow to buy. In any case these areas are unlikely to have any serious near-term banking issues if interest rates rise.
Percentage of Variable Rate Mortgages Per Total: Variable rate mortgages will cause the homeowners that have them to feel the immediate impact of rising interest rates owing to central bank tightening. The same or similar impact may be felt by holders of fixed mortgages if the fixed amount is set for only a short period of time. For the most part, mortgages in American are the fixed variety. In Canada, the number of homeowners with mortgages fixed for at least five years is only about half the total. In Australia, about eighty percent of all mortgages are based upon variable rates. In Finland nearly all mortgages are variable. In Britain and New Zealand, fixed mortgages have locked in periods of less than two years with some less than one year. They would be great instruments to have if rates were falling, but the opposite is occurring these days.
Overall Household Debt Levels: The overall debt load that homeowner families have must be factored in to the equation. If a mortgage was the only debt that homeowners had, the perspective would improve substantially. But add in major amounts of credit card debt, car loans, second mortgages, signature and other personal loans, and the picture of risk becomes much more disconcerted. The European Systemic Risk Board has already warned that many borrowers in Denmark, Luxembourg, the Netherlands, Norway, and Sweden have unsustainably high mortgage debt.
Conclusions: Although the Federal Reserve and other central banks throughout the industrialized world aim to control inflation without forcing a recession, it appears more and more that the concept of the so-called “soft landing” is too remote and perhaps too difficult to achieve. The longer the tightening cycle must continue, the greater the chance of a recession. In spite of the strong demand, the risk of another housing/financial crisis is becoming uncomfortably high.
Sources: The Economist, Braced for a Storm, May 14th 2022.
in the early 1980s we built a new house in phoenix and had a variable interest rate. at that time of hyper interest rates we started out with 13% . three years later it had increased to 16%. it was killing us! “fortunately” {did i say “fortunately”?} a divorce at that time necessitated we sell and get out from under that onerous situation.
I can remember the interest-only loans with balloon payments at the end of a certain term. The balloon payments generally required refinancing at a lower (hopefully) fixed rate.