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The Normal Rate of Interest over History Bookmark and Share


Is the current interest-rate environment a unique environment? 

The answer, in short, is no.

Sydney Homer and Richard Sylla show in their magnum opus A History of Interest Rates that interest rates can remain remarkably sedate (at high or low levels) over a long period. At other times, they can remain remarkably volatile. Over the thousands of years of interest-rate history, it’s all been seen before. 

Homer and Sylla show that real estate loans in ancient Greece held an 8%-to-12% range for two consecutive centuries before the range moved down to 6.67%-to-10% for the subsequent two centuries. In London in the 18th century, the average mortgage rate ranged between 4% and 4.75%.

On our side of the Atlantic, the rate on a mortgage for a borrower of high credit standing was 5.1% in 1900. For most of the first 65 years of the 20thcentury, mortgage rates ranged between 5% and 6%.

Then interest rates (including mortgage rates) began trending significantly higher in the 1970s.

The range in rates has been quite wide over the past 36 years. Quotes as high as 18.375% on a 30-year mortgage were the norm in 1981. Quotes as low as 3.5% occurred last year.  A range of 3.875%-to-4.25% has been the norm for the past year. 

Could market volatility return, with volatility marked by a rising trend? 

Here we are in 2017 with a Federal Reserve determined to raise interest rates and tighten the money supply. We can lean on recent history to gauge a potential outcome.

The Federal Reserve shifted to a policy of increasing the federal funds target rate in 2004. The rate was increased in measured steps to 3% from 1%. The yield on the 10-year U.S. Treasury note barely budged, though, averaging 4.5%.  Over the same time, the rate on a 30-year fixed-rate mortgage ranged between 5.5% and 6%. 

The Fed has taken a similarly measured approach over the past 12 months. Rates on long-term credits have responded similarly, as well: They rose slightly on rumor, but then have drifted lower after the news. 

We’d bet on rates remaining sedate, but we wouldn’t bet the farm. History shows that it wouldn’t be abnormal for the rate range we have today to hold. Then again, history also shows that it wouldn’t be abnormal for rates to be quoted 10 percentage points higher a decade from now. 

The environment we have today isn’t unique, but neither is it necessarily permanent. 

It's All Relative

Housing-market proponents are on guard against President Trump’s tax-reform plans. The plans include doubling the standard income-tax deduction to $24,000 for a married couple and eliminating deductions for state and local taxes. 

If the plans come to fruition, the mortgage-interest-rate deduction (MID) would become less valuable relative to the new standard deduction. Fewer people would itemize, so fewer people would use the MID. The reduced value of the MID benefit will reduce the incentive to buy a home. This is what many MID proponents claim. 

The NAR has been most vocal for maintaining the higher relative value of the MID. The NAHB, which frequently stands with the NAR, has taken a slightly different tack. The NAHB has backed away from the MID campaign and has lobbied more for other incentives, such as homebuyer tax credits, remodeling tax credits, and the exclusion of all capital gains from income taxes. 

Our preference would be to maintain the MID at its high relative value. But if it losses its relative value, we’re not overly worried. Buyers still have a strong incentive to own a home.  

Rarely do any of us do anything for monetary gain alone. The economic analysis downplays the satisfaction of homeownership. Most people prefer to own than to rent; most people prefer to live in a neighborhood of owners than renters. This is based on a psychic benefit, not a monetary one.

The psychic benefit of homeownership is a stronger incentive than many housing proponents acknowledge. What’s more, the psychic benefit is frequently a stronger motivator than the monetary benefit. The numbers matter, to be sure, but so does human nature.  We shouldn’t overlook that. 


Will It Be Different This Time?
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