I Don’t Care About History

The title of this week’s edition is taken from a line from a song by The Ramones – it’s chosen for the irony, of course, because history is a great predictor of the future, and it can’t be ignored. So, find your seats and settle down. Thank you. Today’s lesson touches on the history of the interest rate here in the United States, and there’ll be a test later. No cheating off your neighbor.

• Early 1950s: interest rates were comfortably under 5%
• 1960s: interest rates were at 6% and starting to climb to 8% by the end of the decade
• 1970 to 1980: interest rates climbed to just over 12%
• 1981: interest rates peaked at just above 18%
• 2002: interest rates had worked their way back to 6%
• 2010: interest rates crept back under 5%

In economic circles (you should attend some of their parties – they’re real ragers), this is an almost picture-perfect demonstration of what they call the “60-year cycle”. With the economy being sluggish for the past five or so years, we’ve sort of bottomed out and held, but things are starting to look up, which means we’re starting a new 60-year cycle.

With that in mind, let’s look at a quick comparison for a 30-year fixed FHA loan for $200,000 with 3.5% down – monthly payment (PITI):

4% interest rate: $1,332.24
5% interest rate: $1,448.90 ($116.66 more than the 4% rate)
6% interest rate: $1,572.09 ($239.85 more than the 4% rate)

In the face of these numbers and this reality, a very wise man once said, “Buy your dream house now because you may not be able to afford it in ten years.” If you haven’t already run out to have bumper stickers and t-shirts made with this slogan, I’d highly recommend you do so just as soon as you finish reading this newsletter.

It’s not going to happen tomorrow, but we’ll be back up to 5% interest rates sooner than we think. The difference between a payment at 4% and 5% is significant enough for consideration – you’re looking at a yearly savings of just under $1,400 and an overall savings of almost $42,000 for the 30-year term.

Using history and the 60-year cycle as our predictors, it is very likely that we’ll be back up to 6% interest rates on 30-year mortgages in just ten years. That means that if someone were to buy a $200,000 house now, they will be able to afford much more house and keep their payments more reasonable. Let me explain it another way: in ten years, a $200,000 mortgage, at 6%, is going to cost $5,276.70 more each year, or $158,301 more over the 30-year term of the mortgage. Also, if home values increase an average of 5% each year, a $200,000 home that someone would be buying today would be worth over $250,000; conversely, what $200,000 will buy in ten years will be a house that’s worth just under $125,000 today. If you don’t believe me, do the math yourself. I’ll wait.

I opened with The Ramones. I’ll close with the Rolling Stones: “Time is on my side.” No, it’s not!