People Buy Payments (Or Why Rates Can't Rise)

Authored by Lance Roberts via,

This past week, the lovely, and talented, Danielle DiMartino-Booth and I shared a discussion on the ongoing debate of why “Rates Must Rise.” 

For the last several years, I have produced a litany of commentary (see this, this and thison why rates WILL not rise anytime soon, they CAN’T rise because of the relationship between debt and economic activity.

Most of the arguments behind the “rates must rise” scenario are based solely on the premise that since “rates are so low,” they must now go up. This theory certainly applies to the stock market which is driven as much by human emotion, as fundamentals. However, rates are an entirely different animal.

Let me explain my position using housing as an example. Housing is something everyone can understand and relate to, but the same premise applies to everything bought on credit.

People Buy Payments – Not Houses

When the average American family sits down to discuss buying a home they do not discuss buying a $125,000 house. What they do discuss is what type of house they “need” such as a three bedroom house with two baths, a two car garage, and a yard.

That is the dream part.

The reality of it smacks them in the face, however, when they start reconciling their monthly budget.

Here is a statement I have not heard discussed by the media. People do not buy houses – they buy a payment. The payment is ultimately what drives how much house they buy. Why is this important?   Because it is all about interest rates.

Over the last 30-years, a big driver of home prices has been the unabated decline of interest rates. When declining interest rates were combined with lax lending standards – home prices soared off the chart.  No money down, ultra low interest rates and easy qualification gave individuals the ability to buy much more home for their money.

The problem, however, is shown below. There is a LIMIT to how much the monthly payment can consume of a families disposable personal income.

In 1968 the average American family maintained a mortgage payment, as a percent of real disposable personal income (DPI), of about 7%. Back then, in order to buy a home, you were required to have skin in the game with a 20% down payment. Today, assuming that an individual puts down 20% for a house, their mortgage payment would consume more than 23% of real DPI. In reality, since many of the mortgages done over the last decade required little or no money down, that number is actually substantially higher. You get the point. With real disposable incomes stagnant, a rise in interest rates and inflation makes that 23% of the budget much harder to sustain.

To illustrate this point, look at the chart below. Let’s assume we buy a $125,000 home. I have projected the monthly payment of that home assuming a rise in interest rates going forward back to the long-term median of roughly 8%. Pick a rate in the future and you can see what the payment would be.

With this in mind let’s review how home buyers are affected. If we assume a stagnant purchase price of $125,000, as interest rates rise from 4% to 8% by 2027 (no particular reason for the date – in 2034 the effect is the same), the cost of the monthly payment for that same priced house rises from $600 a month to more than $900 a month – more than a 50% increase. However, this is not just a solitary effect. ALL home prices are affected at the margin by those willing and able to buy and those that have “For Sale” signs in their front yard. Therefore, if the average American family living on $55,000 a year sees their monthly mortgage payment rise by 50% it is a VERY big issue.

Assume an average American family of four (Ward, June, Wally and The Beaver) are looking for the traditional home with the white picket fence. Since they are the average American family their median family income is approximately $55,000. After taxes, expenses, etc. they realize they can afford roughly a $600 monthly mortgage payment. They contact their realtor and begin shopping for their slice of the “American Dream.”

At a 4% interest rate, they can afford to purchase a $125,000 home. However, as rates rise that purchasing power quickly diminishes. At 5% they are looking for $111,000 home. As rates rise to 6% it is a $100,000 property and at 7%, just back to 2006 levels mind you, their $600 monthly payment will only purchase a $90,000 shack. See what I mean about interest rates?

This also explains WHY America has become a nation of renters as affordability for many is no longer an option.

Since home prices, on the whole, are affected by those actively willing to sell – a rise of interest rates would lead to declines in home prices across the board as sellers reduce prices to find buyers. Since there are only a limited number of buyers in the pool at any given time, the supply / demand curve is critically affected by the variations in interest rates. This is particularly the problem when the average American is more heavily leveraged than at any point in history.

Not Just Houses, It’s Everything

The ramifications of rising interest rates do not only apply to home prices, but also on virtually every aspect of the economy. As rates rise so do rates on credit card payments, auto loans, business loans, capital expenditure profitability, leases, etc. Credit is the life blood of the economy and, as we can already see, even small changes to rates can have a big impact on demand for credit as shown below.

More importantly, despite economic reports of rising employment, low jobless claims, surging corporate profitability and continuing economic expansion, consumers have sunk themselves deeper into debt. With the gap between wages and the costs of supporting the required “standard of living” at record levels, there is little ability to absorb higher rates before it drastically curbs consumption.  

There are basically only TWO possible outcomes from here, both of them not good.

First, Janet Yellen and gang continue to hike rates until an economic recession occurs which requires them to lower rates again. As an aging demographic strains the pension and social welfare systems, the economic malaise contains rates at the lower bound. This cycle continues, as it has over the last 30-years, which has created the “Japan Syndrome” in the U.S.


The second outcome is far worse which is an economic decoupling that leads to a massive deleveraging process. Such an event started in 2008 but was stopped by Central Bank interventions which has led to an even more debt laden system currently.

The problem with most of the forecasts for the end of “low interest rates” is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates are an entirely different matter.

Since interest rates affect “payments,” increases in rates quickly have negative impacts on consumption, housing, and investment which ultimately deters economic growth. 

Again, given the current demographic, debt, pension and valuation headwinds, the future rates of growth are going to be low over the next couple of decades until a “clearing” process is completed. (This is what the “Great Depression” provided.)

While there is little room left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases.

This is what the bond market continues to tell you if you will only listen. With the 10-year bond close to 2%, and the yield curve flattening, future rate increases are limited due to limited GDP growth due to “secular stagnation.” Therefore, bond investors are going to have to adopt a “trading” strategy in portfolios as rates start to go flat-line over the next decade.


Pairadimes QE4MeASAP Mon, 07/17/2017 - 14:08 Permalink

This is a big issue that doesn't get talked about. In my Texas town, the average assessment has gone up by almost 60% in five years. People on fixed incomes are being forced to sell. The town is rolling in money and building stupid shit all over the place. When the punchbowl gets taken away, towns all across the country are going to collapse.

In reply to by QE4MeASAP

buzzardsluck Pairadimes Mon, 07/17/2017 - 14:21 Permalink

Texas fucks everyone real well with property taxes   but hey   we don't have a state income tax............... Fuckers can only legally  raise residential properties 10% a year and guess what they do most every year?  No % limit on commercial properties however so they go to town on them and most people are pussies so they don't protest the amount stolen from them.

In reply to by Pairadimes

83_vf_1100_c Pairadimes Mon, 07/17/2017 - 15:02 Permalink

  You in Dallas? They need to fund that bad police, firefighters pension investment. I am very small town TX and they bump it every year. Nice new schools, a football field way beyond what they need but they pack in the crowds every Friday night.  Increasing payments vs interest rate chart... You are a fool if you buy a home with a variable interest mortgage. Fixed rate, pay extra on the monthly to knock down the principal. You're fucked on the county property tax/robbery scheme unless you move to one of the very few states with no tax. They tend to be really cold.

In reply to by Pairadimes

JRev (not verified) Pairadimes Mon, 07/17/2017 - 16:09 Permalink

(Un?)fortunately for Texans, the American South is one of a handful of pockets where QE development cash got shoved. I'm from the Midwest but have lived in Austin and Atlanta - the construction and population booms there are out of control with valuations through the roof.It goes without saying which parts of the country will be raped and pillaged next time 'round. 

In reply to by Pairadimes

michigan independant Mon, 07/17/2017 - 14:23 Permalink

Importing third world voter base with per capita tax is levied to all residents as a flat rate set by the ordinance. No effective raise as inflationary facts whiped out countless thousands as the rest rotted out from the NAFTA transfer programs in the tax code as irs 936. Twitching corpses since the center did not hold.  People do not buy houses – they buy a usury. It was Diocletian who instituted wage and price controls and issued an edict on restraining prices. First you have the massive DEFLATION and then government is forced to debase the money supply that finally reverses the economy sending it into a INFLATIONARY spiral. martin

oDumbo Mon, 07/17/2017 - 14:17 Permalink

Even seen a guy remain on a tight rope forever?  This can't and won't end well, and the disruption will occur much sooner than current forecasts.  Wall Street is now pushing the reset way into the future, which is why it will occur much sooner.  Just watched a Building 7 video about 9/11.  Endless engineers 'proving' all three buildings came down by explosive.  Crazy shit.   

ThorAss Mon, 07/17/2017 - 14:19 Permalink

So the reason why people buy oversized cars is not because the fuel price is low but because interest rates are low. And the reason why oil prices are low is because the cost of funding extraction is low thus creating a glut. Makes perfect sense.

khakuda Mon, 07/17/2017 - 14:22 Permalink

Debt is deflationary
Technology is deflationary
Globalization is deflationary
Measures of inflation are biased to be deflationary by design

Low interest rates which encourage debt and oversupply are also very deflationary

It is the last point central banks don't agree with and miss completely. In their sole goal of stopping disinflationary trends, they exacerbate them and cause asset bubbles which, when they pop, are ALSO deflationary

OpenThePodBayDoorHAL khakuda Mon, 07/17/2017 - 16:16 Permalink

In the 60's futurists extrapolated trends and said we'd all be living a life of leisure by now due to rising productivity, George Jetson worked at Spacely Sprockets but seemed to work about 2 hours per day. But that was not under inflationary money. Thank you Mrs. Fed

In reply to by khakuda

Consuelo Mon, 07/17/2017 - 14:30 Permalink

  Nothing mentioned about foreign owners of our debt; the current move away from $USD trade or the (in a few key areas) attendant foreign policy that could easily, and quite possibly will, negatively affect the low rate environment.   And that would be putting it quite mildly.

rejected Mon, 07/17/2017 - 14:32 Permalink

Credit is the life blood of the economy More like Credit is poison to a economy.Needed/wanted no credit when younger, lived within my means.  Have debt cards now as cheapo businesses have moved to internet,,, pay it off at every billing.In my younger years I could not afford a new home either. We lived in what we could afford. Today I drive around and see many nice older homes for 40-60 thousand but everyone today wouldn't degrade themselves living in a 'used' home. Same with cars and appliances. It's so bad with appliances that used appliance businesses are scarce. Everyone wants new. Went to Lowes, a young couple buying a refrigerator for $2300. It had internet and talked! Watched their selection process. Passed up all the humble $400-700 refrigerators right straight to the biggie!  It didn't even have the storage capacity of the lower cost refrigerators and won't last as long with all that digital crap. As the chart shows the ease of credit seems to destroy common sense. I always hear, you only live once,,, go for it!And the availability of credit drives up cost of everything,,, today it's not $115,000,,, they're running $140-160,000 and going up.

Rainman Mon, 07/17/2017 - 14:34 Permalink

....35, 40, 45 , 50 year mortgages .... right on up the ladder terms will go....a necessary component for a long-in-the-tooth debt supercycle to continue. ( see auto loans.)

Ben A Drill Mon, 07/17/2017 - 14:55 Permalink

Or they don't. Take me for example. Drive a '05 truck. Don't have a smart phone. Don't have cable teevee. Don't have a mortgage or rent or car payment. That's it, that's all I pay every month not including gas, food, smokes, beer.
Do have HOA fees. Do have a internet fee. Electric bill and insurance. That's it.
Still work full time more or less, I leave work early every chance I get.
Just don't care anymore. Traffic sucks, people suck, food stamp people almost equal to non food stamp people shopping.
Retired .gov people getting huge checks every month.

People like me see what this world has come too. It's just getting worse every year. Sometimes I forget I live in the USA. Can't understand what language people are speaking most of the time. Sometimes I do but how does that help if I don't understand them and they give me this look like I'm racist.
Also, most people on food stamps get paid under the table. Most have $100.00 dollar bills in their purse or wallet.

HRH Feant2 (not verified) Ben A Drill Mon, 07/17/2017 - 16:20 Permalink

Welcome to Galt's Gulch. Time to move from being an employee to being self employed. Even if it is only on the weekend. Doing what? Anything. Got a truck? Make dump runs via Craislist. Live where there is lots of wood? Get a log splitter and sell firewood. Like books and movies and music? Buy and sell them on EBay or Amazon. Like vintage clothes (or vintage anything) do the same thing, sell on EBay or Amazon.

There are plenty of people willing to work with you.

I don't take being called racist as an insult. Protect yourself and your family and your neighbor's. If you don't like your neighbor's you can move to another area. If you don't like your family find other people that you do like.

I never explain my point of view to people that are too stupid to understand it. Sadly there are a lot of stupid people out there. Avoid them as much as possible and find other's like yourself.

In reply to by Ben A Drill

robertocarlos Mon, 07/17/2017 - 14:52 Permalink

Debt drives rates lower? Only if you have unlimited money to lend. I thought savers lent to borrowers. Is there that much savings? It's all Qe BS. The more debt the higher rates should be.

NEOSERF Mon, 07/17/2017 - 14:59 Permalink

Charts are fun.  Let's do a real one where the average 56K family income is layered with a $100K in school debt and then tries to buy a $350K house in MA, CA or know, places where there is job growth and people want to live there vs. a shack in Detroit.

Hikikomori Mon, 07/17/2017 - 15:39 Permalink

Eh, I bought my house in '85 with a 12.75% 30 year fixed rate mortgage - it was a good deal at the time.  The world will not end when rates go up.

Harry Lightning Mon, 07/17/2017 - 15:41 Permalink

Lance Roberts has done an excellent job of describing the problems that keep the American economy from growing stronger. Based on the economic argument, he is correct that the higher amount of outstanding debt should cause the economy to remain weak, since money that could have been used for consumption is now ciphered into debt payments. His resultant conclusion that long term interest rates therefore must fall as a result of higher amounts of debt since the increasing debt levels weaken the economy, is wrong from both an historical as well as an economic perspective. The reason he is wrong is because unlike short term interest rates that are set as a function of liquidity demands in an economy, longer term interest rates are decided by two factors. One factor is determined by the perceived levels of inflation that will affect the value of interest payments from the debt over the course of its life. This is known as the Inflation Premium. This premium moves every day, usually in very msmall increments. The second factor that determines long term interest rates is the perception as to the ability of the debtor to pay all promised interest payments as well as returning principal during the life of the debt. This is called the Risk Premium. This premium moves infrequently, but when it does move, the move is usually of great magnitude. For many sovereign borrowers, only the Inflation Premium comes into play in the market's determination of where its longer term cost of borrowing should be at any given time. The Risk Premium is rather static, since few countries ever default on their sovereign debt. However, when a country borrows so much that the ability of that country to repay its debts comes into question, then the Risk Premium can shoot up dramatically. This is why historically we have seen economies that are in recession or even depression have to bear very high levels of longer term interest rates when they want to borrow money Argentina is the paradigm example, although there have been many others. If not for the willingness of the US Federal Reserve to monetize the outstanding debts of the United States through the Quantitative Easing programs during the last eight years, the same phenomenon very likely would have occurred in the United States, especially in 2011 when there was some question as to whether the US and global financial systems would survive the damage inflicted by the Great Recesssion.In the presence of a weak economy were rates of consumer inflation remain low, governments will be able to monetize their debts with little adverse impact on their future abilities to borrow in the marketplace. In that sense, the US and Japan have been very fortunate that their massive injections of liquidity to support their economies have not resulted in increases in their respective consumer inflation rates. Some of that good fortune was engineered, such as when the US re-formulated the way it calculates consumer inflation, making it much more difficult for inflation rates to rise. Part of it is due to the economic advancements that technology has brought concurrent to times of massive deficit spending by these governments. The structural changes that technology has caused in the US economy - particularly the advent of computers in the workfoce that have greatly increased productivity - have had the added affect of reducing inflationary pressures, and even stimulating deflationary pressures. While bad for the overall economy, these felationary effects have allowed the US and Japanese governments to monetize their debts without the corresponding and expected increases in inflationary pressures. Thus, they got away with a cardinal sin.Going forward, contrary to Mr. Roberts' assertion that long term interest rates must remain low due to economic weakness caused by high existing debt burdens, the truth of the matter is that the jury remains out on which way these interest rates will go. Clearly, the future direction of US and Japanese long term interest rates, as well as those of other countries that carry extremely large debt burdens, will be influenced more by the Risk Premium embedded in their longer term rate structure than the inflation premium. Because heavily indebted countries now are at the cusp of the Risk Premium making significant contributions to the composition of their overall longer term interest rate burden. What needs to be answered before we can predict the direction of these longer term rates for heavily indebted countries is where their consumer inflation rates will be in the future. Since our understanding of why these inflation rates is somewhat incomplete, will there be factors that we have not recognized in the past that will cause consumer inflation to rise in the future, contrary to what we have seen in the last generation ? Will asset inflation and the wealth effect caused by a super inflated equity market finally free up the spending habits of the owners of the hyper-inflated assets ? Monetary velocity has been shrinking for the last twenty yerars, in large part because the central banks have so massively increased liquidity. As they reduce such liquidity growth, thus stimulating velocity, will the increased velocity cause consumer inflation rates to continue to track changes in velocity and thus increase ? The answer to these questions remains somewhat clouded because history is somewhat silent as to what will happen in these prospective scenarios. For the US, there has not been so precarious a time since the Civil War, because never in the nation's history ince has its ability to pay its debts been so in question. The heightened Risk Premiu has been offset by a very low (if not negative) inflation premium. Were that inflation premium to rise, it would trigger higher long term rates which very quickly would trigger a massive increase in the Risk Premium. For as I wrote abopve, this premium does not move often but when it goes its usually epic.There are way too many factors at work in the US economy to be able to predict with the accuracy needed for long term investment where long term interest rates will be heading in the US economy. I think a much better case can be made that the Federal Reserve will support the equity market every time it falls bty 20% than  anyone can predict the direction of long term US interest rates. The best strategy in this case, therefore, is to try and look one to three months at a time, and be nimble with your investment decisions.

InnVestuhrr Harry Lightning Tue, 07/18/2017 - 07:24 Permalink

When ALL debt issuers in a category, eg government, have the same high Risk Premium, then the rates do not go up like they would when only individual debt issuers in the category have high debt premium relative to the rest. Government debt is unique because it is essential, so buyers will have to continue buying it even when all the issuers have high debt premium, and the government debt sets the rate for all other debt.

In reply to by Harry Lightning

sinbad2 Mon, 07/17/2017 - 16:55 Permalink

Whilst the author is correct, he misses the real point, which is, THEY don't want people to be able to buy housing. THEY want to own everything, and the people to pay rent, serfdom is the future THEY seek.