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Old 10.01.2019, 14:13
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Low Low interest rates -housing bubble? - inevitable price correction?

Hello All,

As many others, I find the current low IRs for 10y mortgages (1.5%) quite attractive, but as I consider jumping on the bandwagon, I can't help but to think that the relative affordability of the mortgage is just a mirage.

Are people in these bidding wars for properties considering the following risks? If they are, what is their risk mitigation strategy?

1. Prices have increased, depending on the region, between 40% to 80% in the last 10 years. Isn't it reasonable to assume that based on wage to (down-payment) and mortgage affordability ratio we are scratching the bottom of the barrel, so prices can't go up further unless wages increase significantly?

2. Interest rates have nowhere to go but up, and unless another great recession is just around the corner, they will start climbing to control inflation that will inevitably kick in due to the loose monetary policies of central banks.

3. If interest rates go to 3% (where they were in 2007) the interest payment on the mortgage will double. And they can easily go to 4-5% which will be even more painful. Of course, people on 10 year mortgages are "safe" for a while. But isn't it reasonable to assume that in 10 years rates will be higher? Or do people have a crystal ball that tells them that in 10 years we will be in a middle of a recession with low interest rates again and they can refinance at similarly low rates?
I know that banks will calculate affordability based on the hypothetical 5% IR, but are people really prepared to pay it if it comes to that?

4. If IRs go up, they will decrease affordability, and I think it is safe to assume that we will see a price correction (the risky asset's price shall go down to compensate for the increased return potential on the risk free asset). Or people are banking on a booming economy in 10 years with significantly higher salaries and high emigration that will drive up affordability and demand for housing even in a higher (3 to 5%) IR environment?

5. If interest rates go up and there is a 10-15% price correction to maintain "affordability" at the same wage levels, as I understand, banks can make a margin call (i.e. ask people to top off their down-payment to maintain an 80/20 LTV ratio). (Also, there is apparently an oversupply of rentals and more will be coming to the market that will probably start competing with the owner occupied properties for tenants). As many people are struggling with the down-payments already due to the high prices, how will they be able to come up with the cash that the bank will likely demand?

6. Would not it make more sense to buy in a higher IR environment (i.e. before or after a boom) when prices are relatively depressed and assume that if one can afford the mortgage at a higher IR there is an upside potential for savings if rates drop when is time to refinance? Also in a depressed market with high interest rates, one's down-payment can potentially go further than the required 20% minimum and reduce the overall loan amount.

7. After a 10y mortgage expires, at these high property price levels, it still leaves a very significant loan amount behind that sounds risky to me. Also, as I understand, due to tax reasons, most people will keep carrying for the foreseeable future 65% of their original mortgage after 15 years. So a big chunk of debt will always be in the background and only many years of inflation will erode it.

8. In summary, please help me understand why are people so keen to buy property in today's low interest /high prices environment knowing that they only have a 10 year cushion from IR changes and even in this time they might have to give more money to the bank to compensate the LTV change due to the potential price correction?

9. Isn't this "my mortgage payment + maintenance is only 60% to 70% of a comparable rent and I am saving money" thinking just a mirage of a good deal?

10. I am not trying to be negative or judge anyone's decision to buy a property (I know it is very personal and emotional for many people; I would also like to buy), rather I am trying to understand the rationale on the objective and risk mitigation side of the decision.

Thanks,
Huba
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Old 10.01.2019, 14:29
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

Let's not forget how in more popular areas the rents are not likely to drop soon but are more likely to rise, and if the interest goes up, so do the rents. Especially in the long run rents will simply be higher due to inflation and other factors.

When buying I get a certainty for at least the period I set my interest.

For me buying is strictly a calculation thing, and I would buy again to lower my monthly expenses on the long term.

I had to sell my house in the Netherlands after 9 yrs with a loss of 27.5K, however this still was cheaper than when I had to rent that whole period.
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Old 10.01.2019, 14:37
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

i think it is a bet purely on how long the low IR environment lasts.

let's say that IRs go up and causes house prices to go down by 50%.

as long as your net savings from the low IRs are more than the 50% capital loss, then you're still ahead.

so let's say you buy a $1m place which rents for 30k per year. you pay only 1% interest on this (assuming 100% loan for simplicity). so 10k per year and you save 20k per year (again, simplifying).

let's say house prices crash 50% and the place now is worth $500k.

the 500k loss needs to be compensated by 25 years of 20k savings.
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Old 10.01.2019, 14:42
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

It depends on a lot of things, big difference in the long term costs of buying a house is also if you can do all maintenance yourself, or if you have to call a pro every time to fix the toilet and fix a wall socket, not to mention the savings if you install your own heating and kitchen. I can do all myself so maintenance costs are much lower than the guideline.
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Old 10.01.2019, 14:49
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

I can flush the toilet after 10pm, thats worth 500k alone
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Old 10.01.2019, 14:53
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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i think it is a bet purely on how long the low IR environment lasts.

let's say that IRs go up and causes house prices to go down by 50%.

as long as your net savings from the low IRs are more than the 50% capital loss, then you're still ahead.

so let's say you buy a $1m place which rents for 30k per year. you pay only 1% interest on this (assuming 100% loan for simplicity). so 10k per year and you save 20k per year (again, simplifying).

let's say house prices crash 50% and the place now is worth $500k.

the 500k loss needs to be compensated by 25 years of 20k savings.
Let's add a little (but still far from a complete picture)

From the 20K savings you spend 5K on maintenance a year so that is lost, and use the other 15K to pay down on the mortgage.

After 25 years you paid down 375K on the house. There also was the demanded downpayment of 20%, leaving 425.000,- debt. (But owning the house)

I'd say it is safe to assume that rents will go up hugely in a period of 25 yrs due to inflation and salary's going up on every long term period in history. Same with house prices, they rise, they fall. But on such long terms I dare to say nobody will make a loss. And it is only an effective loss if you actually sell.

So in the very long term one will guarantee a much bigger monthly saving when compared to renting.
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Old 10.01.2019, 15:05
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

I would tend to agree and would not want to buy a property here (especially with a large amount of leverage) myself. The low interest rate environment (and therefore expectation of lower house prices in future), plus the low rental yield of property in Switzerland, turns me off the idea.

I think sometimes there can be a mentality of "I pay less on my mortgage than I would on rent, great deal!", while avoiding the fact that actually you're in debt of 700k CHF to the bank and could go into negative equity if house prices fell significantly.
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Old 10.01.2019, 15:10
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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Let's not forget how in more popular areas the rents are not likely to drop soon but are more likely to rise, and if the interest goes up, so do the rents. Especially in the long run rents will simply be higher due to inflation and other factors.

When buying I get a certainty for at least the period I set my interest.

Good point, higher IR will likely drive up rents. But I believe the base mortgage rate for rents is calculated on the average value of all outstanding mortgages and due to the extended period of low IRs adjustments of the base rate will be slow. And will landlords be able to easily pass on IR increases to renters in a not so bubbling economy? Also, what is the base rate's effect on rents? It is probably not comparable with the impact on a loan when going from 1.5% to 3%, which doubles the IR payment to the bank.

A 2-3% IR increase will be a lot more felt for owners than renters. But anyway, you are right, it has to be considered. thanks!
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Old 10.01.2019, 15:13
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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i think it is a bet purely on how long the low IR environment lasts.

let's say house prices crash 50% and the place now is worth $500k.

the 500k loss needs to be compensated by 25 years of 20k savings.
potentially even longer if your 20K saving is reduced by the higher IR
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Old 10.01.2019, 15:14
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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I think sometimes there can be a mentality of "I pay less on my mortgage than I would on rent, great deal!", while avoiding the fact that actually you're in debt of 700k CHF to the bank and could go into negative equity if house prices fell significantly.
Less likely in Switzerland as the banks are usually pretty restrictive in the % of the house value they will lend on (there aren't exactly many 90% - 100% mortgages to be had here). As long as your savings over renting exceed any value drop as per EdwinNL you're still ahead of the game.

BTW the Swiss (still) tend to see a house (as opposed to the underlying land) as a depreciating asset, not an investment and view the finances accordingly.
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Old 10.01.2019, 15:18
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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I think sometimes there can be a mentality of "I pay less on my mortgage than I would on rent, great deal!", while avoiding the fact that actually you're in debt of 700k CHF to the bank and could go into negative equity if house prices fell significantly.

tend to agree, and that 700k debt can become a big burden if something goes wrong in one's situation (health, job, divorce, etc.). But apparently many people are comfortable carrying large debts and skating on thin ice...
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Old 10.01.2019, 15:31
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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I can flush the toilet after 10pm, thats worth 500k alone

That must be a big shit then
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Old 10.01.2019, 15:47
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

When talking about compensating losses with savings from rent, also remember that you've had some capital locked up in the depreciating asset & loan payments that could have been invested (e.g. in dividend paying stocks) if you rented instead.
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Old 10.01.2019, 15:49
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

Also it is in my opinion a game best played on the very long term, if one has no clue where one wants to live in 5 yrs one should not buy imho.
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Old 10.01.2019, 15:50
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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When talking about compensating losses with savings from rent, also remember that you've had some capital locked up in the depreciating asset & loan payments that could have been invested (e.g. in dividend paying stocks) if you rented instead.
Could have, In my situation the money would just be sitting on the bank doing nothing. But yes it is on option.
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Old 10.01.2019, 15:59
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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Could have, In my situation the money would just be sitting on the bank doing nothing. But yes it is on option.
Even over a period of 10 years, just cash in the bank?
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Old 10.01.2019, 16:04
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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Even over a period of 10 years, just cash in the bank?
I'd probably buy a house to rent it out in such case either here or in for example the Netherlands or Germany where a decent house for rental can be bought for less than what is here the downpayment.

But yeah, I personally will not get involved in anything involving stocks this regardless of theoretical profits to be made in future.
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Old 10.01.2019, 16:06
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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I'd say it is safe to assume that rents will go up hugely in a period of 25 yrs due to inflation and salary's going up on every long term period in history. Same with house prices, they rise, they fall. But on such long terms I dare to say nobody will make a loss. And it is only an effective loss if you actually sell.

So in the very long term one will guarantee a much bigger monthly saving when compared to renting.

Based on this chart, asking rents/income is 20% higher than the long
running average. And less than a year ago (2018), UBS has predicted a correction of up to 10% over the next 3 years. Of course, location location... The situation probably has not changed. But with property price increases of 40-70% in the last 10 years, there might be more probable that property prices will go down significantly than rents will go up significantly over a 10 year horizon.
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Old 10.01.2019, 16:11
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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I'd say it is safe to assume that rents will go up hugely in a period of 25 yrs due to inflation and salary's going up on every long term period in history. Same with house prices, they rise, they fall. But on such long terms I dare to say nobody will make a loss. And it is only an effective loss if you actually sell.
I think thats a foolish assumption, anyone who rented a house 25 years ago will be paying a similar rent to when they moved in, it probably did go up 10% but with interest rate falls the rent will have fallen since. Then salaries are not very different, in IT or Banking probably less.
That 25 year old property will need a significant refit soon.
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Old 10.01.2019, 16:12
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Re: Low Low interest rates -housing bubble? - inevitable price correction?

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Based on this chart, asking rents/income is 20% higher than the long
running average. And less than a year ago (2018), UBS has predicted a correction of up to 10% over the next 3 years. Of course, location location... The situation probably has not changed. But with property price increases of 40-70% in the last 10 years, there might be more probable that property prices will go down significantly than rents will go up significantly over a 10 year horizon.
I don't consider 10 yrs the very long term.

If I knew I would in Switzerland only live somewhere for 10 yrs I would probably rent given the prices and investment needed.

If I would have the money (which I don't) to not need to sell the house but can just rent it out when moving elsewhere buying becomes the more interesting option.
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