netmouse | oops, guess that poll question range was too wide, not specific enough

To a great extent, "too high" can't be defined in isolation. It must be defined in contrast to the current rate of inflation. If inflation is running at 15%, then a banking lending money at 12% is losing money on the transaction. One really needs to talk in terms of "real" interest rates, rather than nominal.

Or, to make it clearer, if I could borrow money in Zimbabwe at 100% per annum, that would be a steal, because by a year later I could pay that loan back from pocket change.

Clearly the assumption of this poll is that we're talking about a moderately stable currency, such as US or Canadian $.

Inflation is a difficult thing to gauge. Who do you trust to define it and thus tell you what "real" interest is?

Even in a stable economy such as ours, the 15-18% interest rates that credit card companies were charging when mortgage rates were 10-12% were reasonable, while charging the same rates when the mortgage rate is 5-6% is not.

(I'm not as familiar with exactly where "Prime" has been in the last decade or so, but to my eye, both "high" rates and "usery" can be best measured as how far above "prime" the interest rates are.

According to Moneycafe.com, the prime interest rate (http://www.moneycafe.com/library/primerate.htm) has been between 3 and 10% in the past decade. Right now it's at 3.25%.

I personally never thought a mortgage rate of 12% was reasonable (if it's a moderate or low-risk mortgage, secured by a house whose value (at onset) is more than the value of the loan). Unsecured consumer credit, sure. Mortgage? no. But I might have fiscally conservative opinions about trying to curb inflation as well.

If prime is at 10%, why is a mortgage rate of 12% unreasonable? The Moneycafe chart shows that prime spiked just over 20% several times in the early 1980s. Ye, ghads.

Thanks for the link to the chart; it's interesting to compare it to the smaller swings in rates available to me during that same time period.

With a prime of 10% a 12% mortgage would only allow the banks a 5% "spread" - very low. Out of that 5% would have to come operating costs, taxes, payrolls, etc.

The high interest rates in the '80s were from the Ford/Carter years when Chairman of the Fed Alan Volker was fighting Stagflation by raising interest rates to stabilize the dollar and defeat inflation. (Which is what we need now!)

Voler's action went against almost all contemporary theories and thought about what was needed but was correct and stabilized the dollar's value and I believe made the economic boom of the Reagan years possible. (Reganomics? Pthbbbbbpthb! It was sound monetary policy.)

Bungling Ben Bernancke is doing the things that the nay-sayers wanted back then, and they're as wrong now as they were then.

A 5% spread is low? The current average mortgage rate (for new mortgages) is under 5%.

Uh huh. And how many "points" are being added up front? And mortgage "fees" and brokerage "fees" and are those low rates teasers or fixed or short term or long term or ARMS. Lottsa variables in there. Just because an ADVERTISED rate is one thing, that doesn't make it the ACTUAL (real world) rate. With a Fed funds rate of .25 (+/-), a spread of less than 5% is LOW! (Which is why my minimum ARM rate is 6%)

If PAUL (Not "Allen" DOH!) Volker gets an audience, or if he's not too senile to realize we're having Stagflation not a "liquidity crisis", then those rates can go up plenty and fast!

Statistics on these things are published. Currently, 5.1% (with 0.7 points+fees) for a 30-year fixed, 4.8% (with 0.7 points+fees) for a 15-year fixed. Two weeks ago, they were both under 5%.

FYI - (for those who don't know)

Today's WSJ says prime is 3.25%.

The "prime" interest rate is the rate set by banks. It is usually set at 3% over the Federal Funds rate (but can be higher or lower) When you hear about "the Fed" raising or lowering rates, it's the Fed Funds Rate they're talking about. Then the banks decide where to put Prime. Most banks and credit cards and such use the "prime" as their benchmark to adjust rates for borrowers. For example, my ARM mortgage is readjusted every April 1 to "Prime plus .75% with a minimum of 6% and a max of 16% and a maximum swing of 2% per year."

The inflation numbers put out by the US Government are DOMESTIC ONLY - which means that the Nov '08 CPI was minus 1 (deflation), but for total inflation you must also consider the movement of the dollar against world currencies.

For the bulk of the Bush administration, the domestic US inflation rate was below 5% (usually 2% to 4% or around there) HOWEVER the US Dollar fell against world currencies by over 50% in those same years (40% just from 2000 to 2007, an indication that the decline in the value of the dollar is accelerating).

A 50% drop in the value of the dollar over 8 years gives you an inflation rate of 6.25% per year minimum - not counting domestic inflation. (The domestic inflation rate is based on the cost of a "market basket of goods" in the US and is not connected to the value of the dollar in international markets.)

In the 1981-1982 time period, Bank of Canada rates peaked over 20%. (http://www.bcrealtor.com/d_bkcan.htm) That's what the central bank lends at -- retail rates, even for the best customers, are going to be higher than that.

I think the USA prime rate also peaked over 20% during that period. (http://research.stlouisfed.org/fred2/data/PRIME.txt)

Context still matters.

Retail rates are only necessarily going to be higher than that for institutions who borrow money from the Bank of Canada (or the US fed bank and, yes, we also peaked high in those years). There's nothing stopping independent people or institutions from undercutting the lending market. (If the prime lending rates get high, though, people start to get scared of losing money due to rampant inflation)

Are you saying you don't care how high the interest rate is if it's the government bank charging it? Ir just that you're trying to recognize that all financial institutions tend to operate off the prime rate?

I think that it would be hard to see the "benchmark" rate as usury, and that usury probably has to be defined relative to that benchmark. I have a certain trust that the "benchmark" is not wildly off the mark, but that may not always be the case -- I will hope it is the case in honest, relatively open, stable economies.

And, the benchmark is (supposed to be) high because inflation is high... and again, it comes back to defining against inflation.

And, yes... who measures it? Ok, the difference between 2.5% and 3.7% -- might be tricky, and have to trust. But the difference between 2% and 20% -- that's going to be noticeable to everyone who buys stuff.

ROTFLMBO!!!

Did you just use the words "stable currency" in conjunction with the US Dollar? STOP IT ! YOU'RE KILLING ME HERE!!! LOLOLOLOLOLOL!!!

I believe she said "moderately stable", and was speaking in the context of comparison with the Zimbabwe dollar. And she's completely right; that's why most national governments keep the majority of their reserves in dollars.

Yes, exactly. Current context and conditions are everything.

What type of loan? Short or long term? Secured or unsecured? How risky?

let's say long term, unsecured, risky (but in a reasonably stable currency: let's say an inflation rate of not more than 8%). Is there an interest rate at which you find yourself saying "Oh, come on, now! That's ridiculous!" or not?

What do you mean by "risky"? What % of loan takers do you expect to fail to pay back the loan?

*shrug* what do you mean by risky? I presume we would only be talking the highest risk acceptable to a lender. What's that? I don't know what risk brackets lending institutions tend to operate in, but I would define "risky" as something slightly less than "horrendously stupid" and "sure path to losing billions."

Seth? what did *you* mean by risky?

I don't know how banks "name" levels of risk -- but I'm sure one of the basic measures is likelihood to not pay back.

Ok, let's assume "risky" means that 1 in 20 people will not pay back the loan. Let's also simplify this too 1 year, to make my math easier.

The bank needs to make a profit off this, too.

Inflation 8% -- interest rates can't be less than that, or the bank loses money.
5% loss, means the banks lends out to 20, 19 pay back, therefor the 19 must pay back at least the amount the bank lent out to the 20 -- that's just over 5% right there.

So, to not lose money -- we're starting with an interest rate of 13%.

Now, there is cost of doing business, and profit on top of that. (And cost of capital -- but that gets funny, since banks are (kind of) allowed to lend money they don't have, at least I think that's how they work.) I'd be suprised if that was under 5%, too.

So, 18% is starting to look pretty reasonable from that point of view.

I don't know enough financial math to figure out how a longer term will affect the math, nor how amortization, where some of the capital is also paid off along the way, would affect things.

You forgot that the effect of the 5% loss is spread across the remaining 19 individuals - so, step two is (8% inflation + (5%/19)) = approx 5.26%.

I didn't. When I said "just over 5%" that's what I meant. My calculator is showin .0526 as the value for that as I reply here. I rounded that down to "just over 5%".

Ah, OK, I see now. I was using the wrong numbers to figure the additional rate to apply to the initial 8%. It isn't the (5%/19) I created - it's (total value of one loan/19), which means each of the 19 assumes about 5.25% of the 20th (defaulted) loan. Of course, this assumes all loans are of equal amounts, but from the simplifications inherent in your numbers, that can be treated as a given.

The fact that I screwed up the math I was using doesn't help, either... 5/19 = .26, and I meant to add that to the original 8%. Don't ask me how the leading 8 of "8.26%" turned into a 5. Probably a typo - brain saw '8', finger typed '5'.

It should really be 1/19 of the total at the end (so calculate the interest without loss, inflation + cost of funds + costs&profit, then multiply by 20/19). But the answer give is close.

5% default per year is really high; banks usually won't lend to that sort of risk (or will charge a lot more than their usual rate).

Pretty accurate.

The bank borrows money; that's the .03% they pay on your checking account, or 2.5% they pay on your CD. They can't just create money. (They sort of do: when a business borrows $1 million, that money goes into the business's account at the bank, so the bank's deposits increase by it. As the business uses (spends) it, it leaves the bank.)

Yes, but it's quite high.

Suppose someone is starting a new business, and won't give up equity. I could see a 50% annual interest rate as reasonable (given that if the business fails, he's broke, so the loan is worthless). Likewise if the loan is to the business, non-recourse.

I was hoping for a poll on variable rate loans, because those are what I think are evil. :)

well, and consumer credit cards have started to effectively become variable rate loans....

What makes them evil?

Note that variable doesn't mean arbitrary.

I was speaking with my tongue in my cheek. However, adjustable rate mortgages specifically are a dangerous tool in that they are more difficult to understand and they place the risk on the purchaser rather than on the institution. While they could be used to save money, they have more often been used to help low income borrowers buy more home than they can afford, with the misrepresentation that interest rates would go down. Maybe the misrepresentation wouldn't be an issue if the loan packagers were actually the loan holders in the end, because they could account (in their selection process) for the increase in risk of default that would come when interest rates went up.

They've been used to oversell mortgages by having low initial ("teaser") rates, and having mortgage eligibility determined by the ability to make those artificially low payments. There have been fixed (but varying) rate mortgages with the same misfeature.

The issue is the misrepresentation, not the misrepresented instrument.

Trying to make the packagers the holders can't work: bank employees would still have incentive to lie to get raises/promotions now, and expect to have new jobs before the defaults hit. And if only rich individuals using their own money could lend, many fewer people could afford to buy.

Good points, but I think there is something to be said that mortgages in general are complicated and ARMs are even more complicated. I think even college educated folks have a hard time understanding the risk. The more complicated something is, the longer it takes for the customer to understand. I don't know what the solution is, because I don't really want to prevent people who are willing to go through the hassle of selecting the loan they want, but things that are more complicated are more subject to misrepresentation.

If you don't understand something, you should hire someone who does to either explain it to you or to represent you. Never go into a transaction without knowing how it works.

Believe me, I know how complicated mortgages are. I've written code to price them.

The risks of ARMs are easily explained: "The rate you pay will be adjusted annually to 2.75% over the Treasury Rate. In the past 40 years, Treasury Rates have ranged from 1% to 15%. Are you feeling lucky?"

different ARMs, different rules.

Sure; I glossed over the facts that the rate might adjust annually, monthly, or every N years (from 2 to 7 that I've seen), possibly with a longer initial period. And the spread varies. And the underlying rate isn't always Treasuries, it might be Libor. But it doesn't really matter; the risk is the same: that the rate (hence payment) will increase.

Presuming you mean ARMs, I'd tweak the statement slightly to say that they've been used by evil (or at least amoral) people to exploit people's ignorance. The ARM itself is just a financial tool; it means that the borrower takes the risk/reward of interest-rate changes instead of the lender, and is (or should be) compensated for that risk by getting a lower rate than a comparable fixed-rate loan.

ARMs make sense in two cases:
1) The borrower plans to pay off the loan before the rate adjusts.
2) The borrower believes that interest rates will fall (or at least stay level), and is effectively making a bet on it.

I have a friend who only borrows with ARMs. But he's very financially savvy, and wealthy enough to pay off the mortgage if he needs to; he only has it so that he can use the money to buy other investments.

The evil came in when unscrupulous lenders sold ARMs to borrowers that clearly weren't appropriate for them. And ended up bringing most of our economy down as a consequence.

I agree with

dagibbs. You need to consider the larger economy in order to determine what a good interest rate is. Another key factor is the term of the loan; one might expect a higher rate on a short term loan, for instance, which is a reason banks give for having high credit card rates and low mortgage rates.

In general, I think anything over 10% is excessive, but I admit that I have an aversion to paying interest. I would go for 6% on a mortgage, and as high as 9% on a credit card.

I'm also of the "it depends" camp, but for slightly different reasons. I think that it's legitimate to have higher rates for optional expenditures over things that are closer to necessities. Car loans and home loans should be under %10, preferably under %7 while I think it's OK to have 15% rates on credit cards. I realize some people use credit cards for the necessities of life, but I also think it's a really bad idea to carry a balance on your card for the necessities of life unless it's an ultra-emergency.

I can see that. Car loans and home loans are theoretically also lower risk, since they are secured by property that can be reclaimed if the borrower defaults on the loan.

Who gets to define "necessity"? Neither a house nor a car is; I have neither.

Are you suggesting that rates should be lower when you borrow, but it's OK for them to be higher in cases where you don't borrow?

I think the only reason I answered so high is because of the credit card interest rates (those bastards).

I think it depends a lot on both the kind of loan (size, term, purpose), and the current state of monetary policy (which affects things like how high a return I get on my IRA and my bank accounts).

oops, guess that poll question range was too wide, not specific enough

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