5 ways to beat the interest rate trap

Let’s talk interest rates and the traps you can fall into. Keeping the following ideas top of mind can help you beat the interest rate trap.

* Borrowing – Random Lengths reports today that “thirty-year fixed-rate mortgages (FRMs) averaged 3.84% for the week ending May 3, down from last week’s average of 3.88%, according to Freddie Mac. Last year at this time, the 30-year FRM averaged 4.71%. The 15-year FRM averaged 3.07% this week, down from last week’s average of 3.12%.”

So, it’s a good time to buy a house, right? Yes, if you are planning to stay in it for the life of the mortgage. Otherwise, when interest rates go back up, you’ll have to lower your asking price to sell it at the same mortgage payment you are now making.

Another consideration: in most markets, housing prices are still declining. Let’s say they are going down only 1 percent per year, compared to the 20% to 40% per year of a few years ago. That’s $2,000 off of a $200,000 house. If you hold the house for five years, it will be saleable at $190,000. If interest rates go up, you’ll have to lower the price even more.

How much did you say your down payment was? You are responsible, so let’s say, 20%, or $40,000. Now, look at the decline in purchasing power of the dollar. (see our past commentaries on the Swiss Watch Index.) It’s running about 5% per year these days. Um, that’s 5% in 5 years = 25%. Add the 1% in 5 years in price decline – 5% more, for a total of 30%, or about $60,000 off the purchase price. Your mortgage payments  probably won’t cover that gap. Oops! You are upside down on your mortgage.

* Saving – okay. You’re smart. You’ll rent and put your money into a savings account until you have enough money to buy when the market really does stabilize or even start to go up. It will earn a magnificent 0.7% per year. Wait! You are going backwards. Inflation is currently optimistically estimated to be about 2.2%, so you are losing 1.5% a year in buying power. It’s okay to save, but just for emergencies and near-term expenses. Don’t put your money in the bank for retirement or any other long-term needs.

* Appreciation v. earnings – careful investing in the stock market can get you about 3% in dividends. If the stock price goes up, or appreciates, and it will most of the time, you may start to see growth in both buying power and actual dollar amounts. This has been the main focus of our blog for more than a year. We are well aware that stock prices can go down. Everyone remembers 2008 and 2009, when the market dropped about 40%.

In the meantime, housing prices were dropping 30% to 60% or more, especially in the really bubblicious markets like Phoenix, Las Vegas, and the entire state of Florida. But while stock prices have recovered nicely (see our MPI reports), housing hasn’t.

* Decline of dollar – we already talked about this above, so we’ll just add, “Consider the decline of the dollar PLUS inflation = 7.2% decline PER YEAR for the same dollar! Say you started with a savings account of $1000. In two years that account now is at $1014, but has the buying power of $842.

* Rate of return – this is what stocks, bonds, real estate investments, etc., return to you. It can be a lot or a little. But, whenever you start to think about buying an asset, consider all of these items above.

And finally, when you get a mortgage on a house, remember YOU DON”T OWN THE HOUSE! until it is paid off. Before that, the bank owns the house, you are making payments on the mortgage.

How do you beat this trap? Borrow to buy real estate income property. Keep a close eye on the market, as always. IFO will never do this because she doesn’t have the courage to take that risk. But it is absolutely the way to go if you are young and have the ability to walk away from the investment if things go sour.

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About InvestingforOne

I've been investing in various assets by myself using a discount broker for many years. Over that time, I've developed some theories that others might find useful. Plus, there is more to investing than money. Time, talent, work, friends, family all go into developing a good and satisfactory strategy.
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