[quote=EconProf]
A little history for those under 50 here. TD investments were once really big in the late 70s and 80s when prevailing interest rates were ramping up as inflation gathered steam. In those days existing mortgages were assumable by the next buyer of a house. Remember that mortgage rates and inflation rates peaked around 1980, pre-Reagan and pre-Volcker, at about 18% and 13% respectively. This meant that the lucky homeowners selling their house with a 6% assumable loan in an 18% new-loan-environment had a terrific selling point. So much so that it capitalized into a much higher market value of the house.
Trouble is, the mortgage might only be for 50% of the asking price. Enter the carry-back. The home seller would sell and create a 2d TD for 30% or 40% of the price, so the buyer would only have to come with 20% or 10% down. Terms of the 2d TD might be 10%, 3 – 5 years or so.
But the seller wants cash, not a note, so they immediately advertise in the classifieds (remember them?) or sell to a broker/middleman who would turn around and sell it. But who wants a 10% note in an 18% world? So the note would sell at a discount of, say, 50% or 25% off of face value. This bumps the effective yield to up to 15% or 20%. But if you buy this note, you are instantly buying safety because it is now at a better LTV. Plus, if the house sells or refi’s sometime in the five or so years till maturity, you must get paid off at FACE value, which makes the rate of return go through the ceiling. Trust me, nothing is more satisfying than to get a call from an escrow company saying your note is about to pay off and we’d like to confirm your address for sending the check! Ah, those were the days.[/quote]
EconProf,
You just gave me a “lightbulb moment.” 🙂
The fact that prices were rising in the late 70s-mid 80s when interest rates were rising has been a major point of debate between some bulls and bears.
I think you might have just nailed the reason. If a large enough portion of home sales during that period had assumable loans, then it would explain why prices continued climbing in the face of higher interest rates.
Many of us have suggested that it might have been the inflation expectations from the 70s that caused home prices to rise even while rates were rising, and I’ve often thought it might be due to the fact that Baby Boomers were beginning to enter their peak buying years during that time. While these explanations might be responsible for part of the runup, I think the assumable loans might play an even greater role.
Now, I will have to see if there is any information available that would break down the sales and loan data during that period. If anyone knows if/where this information might be found, please feel free to post it here. 🙂
This also makes me wonder if the PTB won’t make all GSE and FHA loans asssumable in the event we see higher rates going forward (I don’t believe they’re currently assumable, but would love to hear what HLS or another more knowledgeable poster would have to say about this), especially since the govt is behind 90%+ of the mortgage market.
