To The Moon

A seemingly arbitrary figure can inflict real harm.

Photo by Towfiqu barbhuiya on Unsplash

We need to prioritize the tangible over the academic.

The conversation around interest rates is almost invariably the latter. We debate over inflation reduction techniques, talk about things like “homebuilder sentiment” or “lender volume,” and generally take a macro-level approach when discussing the subject. Maybe that’s why so few “regular” people seem to know or care about interest rates.

And that’s a mistake. Because interest rates can have a severe impact on our actual day-to-day lives. Anyone who lives, either previously or currently, in a household with a shoestring budget understands this intrinsically, even if they don’t know the mechanics behind it. In addition to salary stagnation and runaway costs, interest rates help put the squeeze on the working and middle classes.

$40 here, $20 there. It’s not a pretty lethal blow, nor is it death by 1,000 papercuts. It’s more of the “multiple puncture wounds” variety. Several recurring expenses become more…well, expensive, and suddenly, your lifestyle doesn’t work anymore.

When need to focus on the seimpacts when we’re discussing interest rates, inflation and macroeconomic sentiment are worthy subjects, but they’re best left to the experts. The ordinary public wants to know what interest rates mean to their household. We should tell them.

Big ticket

The most obvious impact is on large, financed purchases. This is no surprise. Obviously, a higher interest rate will have a more significant financial impact (in raw totals) on larger balances than it does on small ones. Mortgages and car loans come to mind.

Way back in the ancient times of April, in this very publication,I commented that mortgage volume would be decreasingas interest rates rise. It was part of a larger piece on our housing markets, and it wasn’t a point up for debate. Subsequently,interest rates rose, andmortgage volume declined sharply. This was not a “Bold Prediction”like those on NFL Network on Sunday mornings. This was predictable.

Still, some disagreed. A few pointed out that “the average person doesn’t make a decision on whether or not they need a home based on interest rates.” Absolutely, they do not. No person just abruptly changes their entire life because interest rates moved from 4.15 to 3.85 or vice versa.

Photo byDillon KyddonUnsplash

But the average bank definitely uses interest rates to calculate repayment ability and determine if that equally average person is going to get approved or declined. What the average Joewantsto do is irrelevant if he can’t get financing to buy the house. And, agree with them or not, some folks do monitor rates and may make their rent/buy decision based on timing. If they think they’re coming in at the top of the market, both in mortgage cost and home cost, they may opt to rent for another year.

The difference between a $360,000 mortgage on a $400,000 home (with PMI) at the 2.75% I was giving out in 2021 versus the 6.0% banks are giving nowis roughly $700 monthly.Given that most banks hew pretty closely to a 40% debt-to-income requirement, that comes out to another $1,750 in income needed monthly to qualify, or $21,000 a year. Moving qualification standards up by $21,000 near the median purchase price takesa lotof people out of the market.

The difference in payments as rates increase. Mortgage rates used: 2.75%, 6.0%, 8.0%. By author.

That’s a tangible effect right there — previously, you had an option to become a homeowner. Now you don’t.

That, in turn, can reduce demand, creating a need for price concessions. Price concessions can gradually turn into a down market, which can put recent homebuyers underwater. Particularly the (many) who opted for those 3% down payment programs or people who “took advantage” of 100% LTV equity financing.

Rising interest rates don’t automatically mean a housing correction is incoming, but they certainly make it more likely than it would be in a low-interest environment. And each little hike prices another few thousand would-be buyers out of the market. Should people who arethatborderline be buying or getting approved in the first place? Debatable. But as interest rates move higher, larger and larger incomes get impacted.

Some people also have home equitylinesrather than loans. These were unquestionably more popular as the market soared and people suddenly found themselves with $200,000 in “equity.” Those lines have variable rates. The impact begins immediately.

The accumulation

Increases like that may seem marginally important at best, but that really depends on the household. I spend most of my time writing about the working class. This group (which is way larger than you think) often has a budget that balances by somewhere between $20 and $100 monthly. That’s in a good month — one where no one gets a flat tire, needs to visit a doctor, or accidentally threw out some perfectly good food.

40% of American households earn less than $52,000 annually. You take care of a couple of kids on that salary and you better believe you’ll notice $50. The difference between 4% and 8% on a used car loan, all your credit card APRs trending up, that darn home equity line, etc. The ends might be meeting for now, but for how much longer?

If your debt is getting more expensive at the same time that costs start rising overall (as is happening right now), it can be doubly worrisome. The increased debt service hampers the ability to save properly for increased costs. Those costs make it more difficult to have leftover money for the higher debt service. You get the point.

The only way out of that cycle is with a sudden and fortuitous income increase and, well, good luck with that. People who have time and space for second jobs will pick one up. Those who already have one? Tough luck.

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If you’re wealthy, though, all of this is good news. First of all, people may be more desperate for work, so you may be able to pay them less. Costs and budgets aren’t really a major concern for this group, and the rising interest rates mean a higher yield on their investments and savings. Their increased asset growth should offset any price increases and then some.

That should ultimately pour more fuel on the already-raging inferno that we call wealth disparity. In America,where that trend has been downright horrible for years, this could also exacerbate social and political tensions.

Of course, none of these changes will occur overnight or in reaction to one minor interest rate hike. Taken together and over a sustained period of time? It may be a different story.

Horizons

The stock market had a bad day today, as the Fed appears set to continue raising rates. Of course, that sentence is exactly what turns most people off from the interest rate discussion. I could also add that homebuilder sentiment fell for the 9th month straight, but who cares?

The point is that this climate isn’t getting better. It’s getting worse. Everything we discussed above will be our reality. It’s not an academic exercise. Rising costs and stagnant wages have already pushed the working class to the brink. There’s a good chance they’ve had to take out some credit card debt to cover unexpected expenses. That debt’s about to get more expensive along with everything else.

Of course, this is also happening alongside perhaps the biggest housing affordability crisis we’ve seen in America, with other nations facing similar problems. Not a great time to make things even tighter.

A two-pronged approach is needed. We still need to focus on locking in the wage gains workers saw following the pandemic and building upon them. The freelance and gig economies may continue to do some of this work for us, and trade unions are growing more popular. Still, we’ll need to monitor wages closely when so much of the country is struggling.

The cost side is where we really need some work. Yes, inflation is a problem for these families too, and that’s what the interest rate hikes are meant to combat. Hopefully, they do some good. But are supply chain problems caused by a global pandemic and international conflict something that can be one away with through interest rate hikes? Unlikely.

We may need to get significantly more serious on issues like affordable housing or loosening up zoning laws to allow more multi-unit buildings. The latter is a local issue and will face immeasurable pushback in many communities. The former is up to the federal government and…well, I don’t think I need to say any more than that.

By all accounts, more pain is ahead. We can only hope this storm is short-lived. Many of us are unprepared, and it appears that no help is coming.

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