If hyperinflation were to hit North America, would people with fixed-rate mortgages be able to pay off what they owe with lower-value dollars? Thinking of Zimbabwe and other places where loaves of bread become ten bajillion dollars, could a person pay off their loan for a pittance?
Yes, that’s true for all loans. Lenders take (expected) inflation into account when setting interest rates, but of course a huge spike in inflation would wipe out the returns on loans.
That may not necessarily apply to variable rate loans, however, no? Presumably, a loaf of bread doesn’t become ten bajillion dollars overnight. Could the lender not increase the VRM to, say, 10,000%, to cover the massive inflation?
Fixed rate, good for the borrower.
ARM, good for the lender.
Chance of inflation vs. deflation?
So why would anybody opt for an ARM? As a borrower, you chance of getting screwed are worse than your chances at winning the lottery.
Moral of the story: The fundamental misunderstanding of what is stated above is one major reason why we are in a financial crisis. The degree of utter stupidity is astounding yet the “Masters of the Universe” made it happen.
You mean “of benefitting”?
There’s generally a cap on how much the interest rate for a loan can be increased from year to year. So the borrower should have an idea of the worst case scenario going into a variable rate loan.
To answer your last question first, ARM rates are usually lower than fixed rates, so an ARM turns out better if interest rates stay below, at or a little above the levels expected.
Your analysis of hyper-inflation is not correct. It’s true a borrower would have been better of had he opted for a fixed rate loan, but he’s not screwed. He’s paying back with dollars worth a lot less than people originally thought.
The borrower always wins with unanticipated inflation as he’s paying back with dollars worth less than expected. Interest rates reflect anticipated inflation. ARMs cannot be adjusted by the lender any way they’d like. Their rates are pegged to certain interest rates like the 5 year Treasury rate. So if hyper inflation occurred, and it lasted so that interest rates had time to rise, it’s correct that the borrower would be paying off more dollars than originally anticipated, but not not more dollars than expected at the time the rate was adjusted. He’ll win as long as the inflation was higher than anticipated, and his income is also rising due to hyper inflation.
In addition, there are usually caps on how high an ARM rate can go. This is either in the form of an over all cap or how big any one adjustment can be.
It’s not quite hyperinflation, but I’ve heard of this happening in Iceland on something like a car loan. It doesn’t really get any easier to pay off, since they’re still living in a Kroner economy and are paid in Kroner. If they had foreign currency savings, they would make out, but that’s just currency speculation really.
The real problem is the converse. Sometimes they got loans in Euros due to favorable terms from other country’s banks, and those are very difficult to pay off now. This wouldn’t be a big problem with US mortgage loans though.
An ARM makes little sense when mortgages are at 6%, but imagine a market that was at 12% or 18%. An ARM has downside risk to the consumer when current rates are low, but when current rates are as high as one can imagine them going, they’re less risky than a fixed note.
Real life situation.
I work and live in Japan, where I am paid in JPY. However, I still have student loan debt in the US, with US banks, in USD. The easiest way for me to pay off my debt is to use an international wire transfer every month, converting JPY in my Hokuetsu Bank account to USD, transferred into my Fifth Third Bank account. From there I just let the lendors take what they need electronically.
When I first got here, I could usually expect a transfer of JPY200,000 to, minus a few minimal fees, end up as about USD1850 or so. Ever since the US economy’s meltdown, my JPY200,000 gets me over 2000 smackeroos! Relative to prior payments, that is essentially 150 bucks that I now get for free! It’s only a matter of time before the economy tanks in Japan and the yen follows suit, but until then, I’m enjoying the bonus buxx.
(Sorry for such a tangential post)
Shouldn’t it be easier? I have a car loan. According to my contract, I owe about $10,000, which I pay by monthly payments. If due to hyperinflation I’m now being paid $18,000 a month instead of $8,000, couldn’t I just plop that one month’s extra pay onto my loan and be done with it?
I have an arm. The only time it is foolish is if you do not run the numbers or keep track of your loan.
Compare the starting rate for the arm compaired to the fixed. Also compair the points between the two. My arm has increased this year. But those who are contacting me to help me because of my increase in house payments are offering me loans with higher interest rates.
My loan has a limit on how high it can increase in a year and a cap on the total increase. The cap is around .75% higher than the fixed rate at the time I took the loan out. And cost me less up front.
And if I refinance then I am way ahead.
With all due respect to those discussing, the question is about what effect hyperinflation has on mortgages, not whether ARMs are a sucker bet or not.
I can go you one better. I have two!
The problem here is that most loans are taken in foreign currency, which leads to lower interest rates (since the ones here have been quite a bit higher than in most of the world), so when the ISK plummets your loan becomes that plummet in % (70-80% this year) more expensive. So that’s not connected to inflation in any way.
And the mortgages taken in ISK are usually set up with a fixed interest rate PLUS yearly inflation (adjusted at the end of the year), so people are looking at about 30% interest this year. The reason inflation is added to the regular rates is to keep them low, which then kinda backfired this year.
(why yes, I’m very pleased to be renting).
I accidentally my arm.
My wife was still living in Mexico back in 1995 (currency crisis). For some reason, it seems that virtually every, single loan was adjustable rate, or otherwise had a clause for rates to adjust due to some event (like the failure of the old Peso). Lots of people lost lots of stuff. I don’t mean the poor that have nothing to lose, but the regular middle class people who are very similar to us.
Yes.
When mortgage interest rates dropped down below 5.5 % fixed, I considered it a reasonably sound decision to take out 30-year fixed money, particularly since the delta between 15 and 30 year money was so low. You can pay back the 30 year money at an accelerated rate as long as it’s financially advantageous to do so, and should interest rates skyrocket past the rate of your loan, you can drop back to the 30 year rate and use what your were paying in extra principal to earn more money than you are paying in interest.
In my opinion, the chance that 30 years will pass before interest rates soar again is minimal, so as long as you plan on keeping the house indefinitely, it seems more prudent to take out long-term money while rates are low. Were the delta for 15 and 30 year fixed rates higher, the equation changes of course. I assume that among the reasons that delta has shrunk so low is that people just don’t stay in their houses long-term anymore.
I don’t like having a mortgage at all, as I am very conservative fiscally, but there are days when it’s tempting to mortgage my house to the hilt to get long-term use of cheap money. Right now things are deflating but the end-game for most countries that really hit the financial skids is to try and inflate their way out of it, as you have noted.
It’s interesting to note that the concept of a “fixed rate mortgage”, where interest rates are fixed for the entire amortization period of 20+ years, is virtually unknown outside the United States - in a liberalized market, no bank or depository institution would survive the risk of loaning money at fixed rates for 20 years. They didn’t exist in the US either prior to the Great Depression. Such loans exist in the US almost entirely due to the American industrial policy of massive government intervention in the form of Fannie Mae and Freddie Mac.
You beat my brother he has only one.