Property and Inflation

[tanmedia1]

I thought some might appreciate this from Australia's Money Morning.

THE QUESTION
"Why wouldn't you pay off the mortgage over a longer time period with
inflated dollars (ie a devalued currency) especially if you can fix
the interest rate when it is low?"

"Hypothetically could you have bought a house in Zimbabwe years ago
for $500,000, and assuming you were able to fix the interest rate
until now, go into the bank and pay off your mortgage with a million
dollar note and tell them to keep the change?"

THE ANSWER
It's a fair point. In fact, not only is it fair, but it is logical. If
you do believe that inflation is a bigger menace than most mainstream
commentators believe it to be, then it does indeed make sense to delay
repaying debt.

How so? Well, thanks to inflation, the principal amount of your loan
declines over time while theoretically your ability to service the
loan rises. Therefore a $500,000 loan in today's money would only be
the equivalent of $475,000 next year if you assume an inflation rate
of 5%.

Of course, it does rely on a number of other factors to make it
beneficial. Your salary also needs to increase otherwise you are
paying more for other goods leaving you with less dollars.
Plus, the interest rate you are receiving on any savings needs to be
sufficiently high in order to keep pace so that your savings are not
becoming devalued.

But, remember that inflation is the enemy. It is not your friend. And
trying to turn it into your friend could lead you into big trouble.
The idea of fixing a reasonable interest rate for as long as possible
makes sense. As we have noted before, today you can lock in a 15-year
mortgage with the major banks for less than 7%. When the recent
interest rate cut feeds through to all the banks this could see the
rate drop to 6%.

If you've maintained your repayments at the same level as last year
(when mortgages were over 9%) then fixing at the new level will see
you pay off the mortgage within the 15-year loan period.

But, the trouble with 'wishing' for a hyperinflationary environment
where you can buy a house for peanuts is obvious. Take a look at
Zimbabwe today. Do you see citizens jumping for joy because they had
the fortune to lock in interest rates ten years ago and are now the
proud owners of a luxury villa?

In a hyperinflationary environment there are very few real winners. We
don't have the space to go into the full details, but we can certainly
touch on the key points.

It is important to remember that rising wages lag inflation. And that
even though your fixed rate mortgage may become proportionately
cheaper to you, all other purchases will become proportionately more
expensive.

And it also assumes that you are able to maintain those repayments
during periods of high - but not hyper - inflation, say of 10% or 20%.
Remember that if your mortgage repayments currently equal about 40% of
your income, then your other purchases (disregarding any savings) make
up the remaining 60%.

Yet after only two years of 10% inflation you will need 112% of your
original income in order to maintain the same lifestyle. Yet even if
you are lucky enough to get a pay rise you are still lagging behind
the rising prices.

Further, you need to consider the role of government and its future
taxation requirements. It is more likely in an era of higher
inflation, higher interest rates and higher unemployment that the
government will need to increase taxation as revenues fall and costs
rise.

This has a further impact on your disposable income and the ability to
meet mortgage repayments.Buying a house today, crossing your fingers and hoping for hyperinflation so you can pay it off sounds like a great idea.Unfortunately there is no such thing as a free lunch.

The other point that Quinn from WA mentions is that "people will rush
to exchange their devalued cash for tangible assets when they realize
that government policies favour continued periods of inflation."

Which brings us to the next point. Supposing you have just paid off
your house with a stamp and are living like a king, does it matter?
The answer is probably not. Because in such an environment, housing
will be seen as little more than the need for shelter. In fact, the
larger the house the larger the burden it will be to maintain as those
costs would be significantly higher compared to a more modest
dwelling.

Therefore, in terms of owning assets your only hope is to have
something that is exchangeable and holds its value. For example gold
or silver.

In the meantime, it's probably worth hedging your bets that you won't
see a hyperinflationary environment. And therefore the best bet is to
ignore the pleading of government to spend, and instead keep mortgage
repayments as high as you can and lock in an interest rate when it
looks as though rates may start to rise again.

[Badger]

I got more out of that then Olly's article

nice one!

[Austrokiwi]

TM1 Post is interesting but in a hyper inflationary period I suspect banks will be able to break low fixed interest agreements under the principle of force Majeur (xcuse spelling please)

[Wayne]

TM1 Post is interesting but in a hyper inflationary period I suspect banks will be able to break low fixed interest agreements under the principle of force Majeur (xcuse spelling please)

I doubt that.

[exnzpat]

Nice post Tan.

It’s nice to have a little perspective.

I agree with Wayne -- unfortunately for New Zealander mortgage holders – the banks don’t need to force interest hikes on people because no matter what happens in the future; New Zealanders are forced to fix or float for very short periods of time. Five years being the longest “fixed rate” that I’ve seen.

What we are seeing here in the States is the interesting phenomena that lowered interest rates have not spurred the economy forward like they are supposed to. This is the role that higher interest rates are supposed to play – to slow the economy! This is pretty amazing – it’s like we have collectively run out of money all at the same time! Lowered interest rates should jumpstart the economy so what happens if inflation really begins to pick up? Currently we are seeing about 3-5% inflation in the US. If inflation begins to increases – what then?

Either way, I think: this could end badly.

[Austrokiwi]

I doubt that.

Of course your welcome to doubt it. During the German Inflationary period There was no breaking of fixed interest rates but the German Government attempted to appease Mortgage Bond holders by recompensing them with compensation ( paid with more newly printed money).

The situation was so bad that at its worst workers were paid three times a day, often wives would collect their husbands pay and rush to the shops ( which were usually empty) to purchase anything they could find before the money devalued so far as to become useless. Farmers refused to deliver their products to the cities as the money they received was worthless..this lead to food riots and union led food looting raids of farms.


As the article suggests it was initially great for those with mortgages their debts disappeared over night. For those forced to sell ( not uncommon at that time) at that time it of course it was devastating. At the end of the inflationary period though, the majority of those who had had inflation wipe their debts on their houses, had to re borrow ( no savings I guess: I am not really sure why some one else may be able to enlighten us). The new borrowings were more punitive and saw many back at square 1.

Intriguingly Germany started the inflationary period with full ( I think gvt sponsored) 100% employment.

[exnzpat]

Of course your welcome to doubt it. During the German Inflationary period There was no breaking of fixed interest rates but the German Government attempted to appease Mortgage Bond holders by recompensing them with compensation ( paid with more newly printed money).

The situation was so bad that at its worst workers were paid three times a day, often wives would collect their husbands pay and rush to the shops ( which were usually empty) to purchase anything they could find before the money devalued so far as to become useless. Farmers refused to deliver their products to the cities as the money they received was worthless..this lead to food riots and union led food looting raids of farms.


As the article suggests it was initially great for those with mortgages their debts disappeared over night. For those forced to sell ( not uncommon at that time) at that time it of course it was devastating. At the end of the inflationary period though, the majority of those who had had inflation wipe their debts on their houses, had to re borrow ( no savings I guess: I am not really sure why some one else may be able to enlighten us). The new borrowings were more punitive and saw many back at square 1.

Intriguingly Germany started the inflationary period with full ( I think gvt sponsored) 100% employment.

What I was refering to in my earlier post was New Zealand Loan structures. Australian/NZ banks don't need to force themelves on the New Zealand mortgage holder.


I don’t know how loans work in Europe but most probably (my guess) is that they work pretty much the same way they do in the USA, that is, that they offer two primary types: Fixed and Adjustable. On these two there are a variety of themes.

In New Zealand the standard mortgage is a variety all unto itself. A fixed mortgage is not fixed at all but will become adjustable at some point in the future. For example (using my own experience) a mortgage can be fixed for 5 years but is based on a 25 year schedule – this normalizes monthly payments – but after 5 years and if the interest rate were to double I would now be tied to entirely new monthly payment based on this new interest rate. Not only is this unfair – it is outrageous! The bank wins. The bank always wins. From a consumer standpoint this is a very unfair practice. Though, I wonder why this is. Normally, loans like these are offered only to high risk consumers elsewhere. Are Australian/New Zealand banks sending us a subliminal message?

In the USA I can get a fixed mortgage for 30 years at say 5.5%. After 30 years, if I do nothing, I’m still paying 5.5% -- even if interest rates have sky-rocketed to 12 or 15%. Very simple and very secure.

The variable nature of New Zealand mortgages creates uncertainty in the market place. If interest rates go up your mortgage will eventually catch up with you. And at the appointed time for refinancing you will either be out on the street (if you can’t pay the new mortgage payment) or struggling to make ends meet to make a payment. But, the reverse may also be true if interest rates have dropped then so too has your mortgage. However, having said this, I dare any of you to compile statistics of past average mortgage interest rates. I suggest you take a stiff drink before you do!

[spurner]

So why don't NZ banks offer 25 year fixed interest rate loans?

Maybe the revered RR or someone can enlighten me?

[Austrokiwi]

So why don't NZ banks offer 25 year fixed interest rate loans?

Maybe the revered RR or someone can enlighten me?

I'm guessing...... but I think the 25 year fixed rates died with the old very expensive table mortgages. I think NZ and Aussi banks would offer long term fixed rates if they thought their customers would "buy" them. MOst people in NZ ( don't know the Aussi scene) change houses at least once every 7 years, and I recall my mind set when I lived in NZ, I wouldn't have committed to a 25 year rate for the simple reason I would have believed that over the time I held the house I was likely to see lower rates. I'll see what I can find out about costs of breaking such mortgages here in Austria.......but I suspect its not an issue as the culture here seems to be: You start with an apartment or human battery farm (row house) hold that for at least 10 years and then buy a house that you hold and pass on to your off spring

[exnzpat]

So why don't NZ banks offer 25 year fixed interest rate loans?

Maybe the revered RR or someone can enlighten me?

The answer, I think, lies with bank fees, greed and the continual fear that the banks see a missed opportunity to shovel more money into their pockets. New Zealand and Australia only have a handful of banks while the USA has many thousands. More banks mean more competition and that means better deals for consumers and this is just not true in New Zealand or Australia.

As property values continue to fall we can probably expect another lowering of interest rates. As I have said before (based on what is happening here in the States and Europe) this will not spur the economy forward like it is supposed to. Eventually, I expect to see interest rates increase again at some point in the near future -- to check inflation – it is at this point that New Zealand home owners, even with good debt to income ratio will be squeezed. And it is these people who are stabilizing what will be left of the property market at this future time. And it is these people the government should step in to help. The easiest way is to force the banks to offer refinancing on long term agreements such as 10 year fixed, 15 year fixed, 20 year fixed, 30 year fixed and if need be even 40 year fixed mortgages -- with refinancing only at the borrowers option – not the lenders. And in this way, the government exposure to the housing crisis (NZ does not have one yet – but will) will be minimal.

While I’m personally opposed to government interference in private markets I see this method as an acceptable alternative to pumping tax-payer dollars into a sinking ship i.e. the banks with stressed assets and a renter-class style form of home-ownership with mortgages that self perpetuate this dysfunctional economic base. By “base” I mean that secure and safe homeownership is not only an economic necessity but also a democratic necessity – lose one and you lose the other.