If you’ve got decent credit you can get a mortgage right now for somewhere around 4.5% or less.  These are lows not seen in a lifetime and likely not going to be seen for a lifetime to come.  Interest rates on other loans are also at lifetime lows.  But people still aren’t buying houses and businesses still aren’t borrowing money.  Why?

Well banks won’t loan it to them.

A quick refresher on how banks make money.  They borrow it from you and me in the form of deposits, or borrow it from the Fed, or sell bonds or stock to investors.  The cheapest way to borrow money is usually from depositors or the Fed.  Right now either of them will charge less than 1% to borrow those funds.  So the spread (the difference between the two) on deposits with mortgages is about 3.5%.  So for 30 years the bank will make 3.5% while bearing the risk that you’ll default, and the risk that if you default your property is worth less than the mortgage, AND dealing with the increased costs of paying depositors if interest rates go up in the next 30 years.  Doesn’t sound like a lot of fun.

Contrast that with the 30 year loan they could give to the government.  Right now that’s about 3.5%.  All those risks listed above exist for the 30 year Treasury except their likelihood of default is much smaller than you.  So is the risk of you defaulting worth 1% to a bank?  The answer is no. Especially when you think about the cost of doing a mortgage in terms of overhead compared to just buying Treasuries.

This is why despite low interest rates, banks still aren’t lending anyone money.  If interest rates were to rise, banks would see their spread increase (deposit and loan rates don’t move in lock step) and you and your house might be worth the risk and effort again.  This is related to the liquidity trap.  Call this the interest rate squeeze.

This doesn’t mean for certain than interest rates are too low.  If housing started to increase in prices, the banks might look at you differently.  But right now, given all the inputs, we’re not worth the risk.

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categories: banking, economics, Housing, investing, loans, personal finance