Why are US Home Sales so Bad?

This week, many US news agencies reported that home sales are down, prices are weakening, and it's all deeply confusing. Since interest rates are falling, shouldn't home sales be rising? Isn't that what Economics 101 teaches us?

Pundits give many possible reasons for this strangely low level of sales: lack of available credit, bad seasonal weather, weak consumer confidence, weak jobs outlook, tough mortgage lending standards, and more. I believe all of these excuses are nonsense.

Banks are willing to lend, and have the cash to do so. Consumers have the highest credit ratings they have had in years. And, bad weather doesn't account for nationwide weakness.

The reason US home sales are low is because people with excellent credit and good jobs simply have no reason to buy. This explanation is far too simple for economists to embrace, yet it is true. Take, for instance, the conversation I heard on Friday:
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Banker: "I haven't seen you in a while. Did you buy that property in Phoenix you were looking at?"

Client: "No, not yet. Prices are great down there! But, they're not going up. I heard on the news they might still be dropping. I don't think there's any rush. I think I'll just sit tight."

Banker: "I agree."

Client: "The prices sure are great, though."
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I hear conversations like this every day.

Thousands of investors are waiting to "jump in," but there is simply no incentive to buy right now.

At some point, of course, prices will take off like a rocket ship - that is, slowly at first, gaining momentum steadily (once people realize prices are rising again) until going at full speed. However, no one knows when that point will be. It could be years.

Strangely, and counter-intuitively, I believe that in order to spur home purchases, the Fed should do exactly the opposite of what it is doing. That is, it should steadily increase interest rates. Last year, when the Bank of Canada announced that it would be raising rates, there was a frenzy of buying activity (which has since slowed, since they are now lowering rates). Contrary to every economics paper every written, I think the reality of rising rates would kick-start a home buying recovery.

In any case, my advice (as I have pointed out previously), is that if you want to buy real estate and are able to do so, do it now. Interest rates are extremely low, prices are extremely low, and with a large number of homes on the market you can choose whichever property your heart desires. Buying at a time like this will never be a bad investment.

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"Space is big. You just won't believe how vastly, hugely, mind-bogglingly big it is. I mean, you may think it's a long way down the road to the drug store, but that's just peanuts compared to space."

Douglas Adams

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See also:

If Mortgage Rates Keep Falling, Why Are Home Sales So Bad?

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Should you Lock it In?

Today’s interest rates -- the lowest since the 1950s -- were the response to a worldwide credit crisis and never meant to last forever. With both the Federal Reserve and the Bank of Canada hinting that rates will soon be increasing, is now the time to lock in your mortgage rate? Or, should you keep your rate variable and ride it out?

Since the late 1980s, variable rate mortgages have saved homeowners money over fixed rate mortgages. That is, on any given year, you would have been financially better off to take a variable rate mortgage (which has a lower rate) instead of a fixed rate mortgage (which has a higher rate but that is guaranteed not to increase). Variable rates could and sometimes did rise, but never enough to make the fixed-rate option worthwhile. As a result, many advisors now state unequivocally that variable rate mortgages are superior to fixed. The recent past, however, is not necessarily a good indicator of the future; and money is not the only consideration.

The next twenty years are unlikely to be the same as the last twenty. Countries around the world have run up huge deficits to combat global recession and have expanded their money supplies. The possibility that interest rates will rise dramatically to fight inflation is still relatively low, but it is real. If a hyper-inflationary scenario plays out like it did in the early 1980s, a fixed-rate mortgage will be a lifesaver.

Another consideration for a fixed rate mortgage is the psychological aspect, which is huge but often ignored. Financial prowess involves making practical decisions and planning for the future. Variable rate mortgages make long term planning difficult. How can you accurately budget, for example, if you don’t know what your next mortgage payment will be? There is also the serenity that comes with hearing an announcement that interest rates will rise, and not caring. You may pay for this economic certainty, but the psychological benefits are tangible.

The final consideration is protecting your downside risk. If mortgage rates rise only modestly, you may regret fixing your rate. But really, the worst that can happen is you don't save as much as you could have. If rates climb far above and beyond your fixed rate, however, you will be eternally grateful that you locked yours in. A fixed rate is, in effect, a form of insurance against events that could upset your financial security.

In short, I am advocating locking in to a fixed rate. With present rates at historical lows, the downside risks (such as rapidly rising interest rates) are far greater than the upside risks (such as missing out on a 1-2% rate discount). And, the ability to plan for the future, knowing that your monthly payment will not increase, is a valuable asset in itself.

Unless you like gambling, lock it in.
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"Beware the investment activity that produces applause: the great moves are usually greeted by yawns." Warren Buffett, 2008 Berkshire Hathaway Annual Report.