The combination may not last

20 October 2014
The message is clear. American home loan borrowers are slashing spending to accommodate rising home loan payments. Clearly, both property prices and home loan interest rates are expected to rise, albeit gradually.
If home loan interest rates begin moving up, property prices could begin moving South. That would mean a squeeze on end-user investors who are over-leveraged and such a squeeze could finally force the economy move on to a slow track. When that correction takes place, expensive home loans would result in unaffordable properties.
Consider this illustration. If the interest rate on your $ X floating rate home loan raises by one per cent, property prices will have to fall by more than that rise. So that EMIs are intact.
There are no two ways about it. If home loan interest rates are going to rise, it will hurt home loan borrowers. If home loan interest rates move up faster than the rise in home values, that will leave homeowners’ equity whittled down.
For instance, if an end-user investor owes US $ 0.9 million on his apartment which is valued at US $ 1 million and his property price falls by 10 per cent, the home loan borrower’s equity shrinks to zero.
So, home loans can keep property prices afloat only for a while. That is because property prices cannot rise faster than incomes forever. If property prices stop rising, end-uses are sure slash spending.
If today properties are generally affordable, that is because home loan interest rates are low, which means lower EMIs. Therein lies the paradox: cheap home loans can make homes expensive tomorrow.
The crux of the story: property prices are rallying today on an unsustainable combination of strong income growth and strong asset value, plus lower interest rates.
This combination may not last too long. When that combination comes to an end, that will be bad news for realty.
Harish Kumar
hkumar2d@gmail.com
https://www.smashwords.com/profile/view/harishkumar

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