Interest Rates Going Up??

I did some reading this weekend that makes me think interest rates may be going up in the near future. Every weekend I get a copy of John Maudlin’s weekly letter and Alice Roe’s “Mortgage Market In Review”. Both of them this week talk about the spectre of inflation. Here are a couple quotes….

John Maudlin, “I think the bond market is looking a few years down the road and saying that $1-trillion deficits are simply not capable of being financed. And if the debt is monetized, then inflation is going to become a very serious issue.”

Monetizing the debt means that the government may begin buying back some of the bonds that they sold to go into debt in the first place. If they buy the bonds back, they are increasing the money supply which causes inflation.

Here’s one from Mortgage Market In Review, “There are concerns all across the globe that the US will lose its AAA credit rating. Standard and Poor’s recently downgraded the UK from stable to negative. Many analysts expect the UK to lose its AAA credit rating. Market participants are concerned the US will follow as deficit spending continues. Bond guru Bill Gross said it would happen in “at least three to four years, if that, but the market will recognize the problems before the rating services – just like it did today.”

Just as in the case of a consumer, a lower credit rating would mean that the government would pay higher rates to borrow money. This is logical in that an investor requires more return for the additional risk of possibly not being paid on their investment. This would most likely result in interest rates rising on not only Treasuries but also mortgages. As warned last week, it is a great time to take advantage of rates at the current levels to avoid the uncertainty of where mortgage interest rates will be in the future.”

If we do get inflation we will see interest rates increase. If interest rates increase, the amount of house you can buy for the same amount of money decreases substantially.

For example, lets say you were qualified to buy a $200,000 house at 5% interest. That’s pretty close to where the interest rates are right now. But lets say the interest rates suddenly jump to 6%. Now you can only buy a $179,000 house. There is a substantial difference between a $200,000 house and a $179,000 house.

What if they jump by 2%, from 5-7 percent. That is not at all out of the question, in fact some people are predicting double digit interest rates soon. If your interest rates jump to 7% from 5% and you were qualified for a $250,000 house at 5% interest rate….now you can only buy a $202,000 house.

So it may be a good time to lock in these interest rates. In addition, you can take advantage of the AHFC’s $7,500 energy rebate and the US Government’s $8,000 tax rebate if you are a first time home buyer.

I want to temper my comments about rising interest rates to say that the more I read about economic forecasting the murkier it gets. There are also some people saying that we will get massive deflation. If so, it will be like the depression where interest rates will drop, but so many people will lose their jobs that they won’t be able to buy anything.