The Locked-In Effect: How low Mortgage Rates Impact the Housing market
The US housing market is facing a unique challenge: the “locked-in effect.” This phenomenon describes homeowners with mortgages secured at rates considerably lower than today’s rates. These homeowners, often boasting 30-year fixed-rate mortgages below 4%, are reluctant to sell and perhaps face a much higher mortgage rate on their next home.
As Wolf Richter of Wolf Street notes, “The ‘locked-in effect’ has bedeviled the US housing market ever since mortgage rates went back to the old-normal levels in the era before QE, before 2009.”
The desire to stay in these deeply discounted mortgages creates a ripple effect in the housing market. These homeowners are both less likely to buy a new home and less likely to sell their current ones, effectively shrinking the pool of available properties.
This stagnation in the market has contributed to a decline in demand. Data shows a notable drop in sales of existing homes,reaching levels not seen as 1995,despite increasing inventory.This trend is detrimental to various players in the industry, including real estate agents, mortgage lenders, and brokers, who rely on transaction volume for revenue.
While some homeowners trapped in this scenario might stay put indefinitely, life throws curveballs. Divorce, job changes, unexpected corporate policy shifts requiring relocation, or even natural disasters can force homeowners to sell.
In these situations, the homeowner must acknowledge the reality of today’s market. They have to pay off their low-interest mortgage and acquire a new one at a significantly higher rate. This can lead to a “payment shock” that significantly impacts their monthly budget.
This trend is further emphasized by the growing share of mortgages with rates of 6% or higher. According to Wolf Richter, this has more than doubled to 17.2% at the end of Q3 2024, reaching its highest point since Q3 2016. This spike, contrasting with the dwindling share of mortgages below 4%, paints a clear picture of the shifting landscape of the housing market.
the Shifting Landscape of US Mortgage Rates
Mortgage rates in the US have undergone a significant shift in recent years, leaving many homebuyers and homeowners reflecting on the affordability of their dreams. Currently hovering just above 7%, the average 30-year fixed mortgage rate has climbed steadily as September 2022, consistently surpassing the 6% mark.
This upward trend is starkly contrasted with the period from mid-2020 to late 2021, when rates plummeted to below 3%. This historic low sparked a mortgage refinancing boom, with nearly a quarter of all outstanding mortgages by Q1 2022 sporting these remarkably low rates
“Obviously, this share of 17.2% is still very low. But the share more than doubling in two years is a rapid increase. It reflects purchase mortgages and refinance mortgages with rates of 6% or higher,” insights suggest the changing landscape of mortgage borrowing.
Historically, 30-year fixed-rate mortgages dipped below 4% intermittently starting in 2012, a characteristic of an era marked by quantitative easing (QE) enacted by the Federal Reserve. The Fed’s large-scale purchases of bonds, including mortgage-backed securities, played a significant role in suppressing mortgage rates during this time.
However, the reality is these historically low rates are unlikely to prevail forever. At some point, homeowners locked into these favorable terms will inevitably face the need to refinance, potentially at significantly higher rates.
“So these below-4% mortgages are not forever. At some point, “locked-in” homeowners find themselves in a position where they want to, or have to, pay off the old mortgage and take out a new mortgage at a much higher rate. And eventually the locked-in effect begins to fade.”
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What are the potential impacts of the “locked-in effect” on the housing market?
Archyde Interview: Unlocking the “Locked-In Effect” with Dr. Amina Patel, Housing Market Economist
Archyde’s Human News Editor, Jordan：
Hi everyone, today we have a engaging discussion lined up. Dr. Amina Patel, economist and expert in housing market dynamics, has joined us to shed light on the ”locked-in effect” and its impact on the US housing market. Dr. Patel, welcome to Archyde.
Dr.Amina Patel:
Hello Jordan, thank you for having me. I’m excited to discuss this interesting phenomenon.
Jordan:
Let’s dive right in. Could you explain the “locked-in effect” to our readers and how it’s influencing the housing market?
dr. Patel:
Certainly. The “locked-in effect” refers to homeowners with mortgages secured at rates significantly lower than today’s rates, usually below 4%. These homeowners are reluctant to sell and possibly face much higher mortgage rates on their next home. This creates a ripple effect, reducing both the likelihood of homeowners buying new properties and selling their existing ones, thus shrinking the available housing inventory.
Jordan:
We’ve seen a decline in demand, with existing home sales dropping to levels not seen since the mid-90s. How is this stagnation affecting various players in the industry?
Dr. patel:
The decline in demand is indeed Concerning. Real estate agents, mortgage lenders, and brokers all rely on transaction volume for revenue. With fewer sales, their businesses suffer. Additionally, homeowners face challenges when life circumstances force them to sell, as they’ll need to pay off their low-interest mortgages and obtain new ones at significantly higher rates, potentially leading to a ”payment shock.”
Jordan:
Wolf Richter from Wolf street has noted that the ‘locked-in effect’ has been a persistent issue in the housing market since rates went back to pre-2009 levels. What’s your viewpoint on this?
Dr. Patel:
Wolf Richter is correct. This phenomenon has been with us for quiet some time. As mortgage rates move over a longer period, the proportion of homeowners with deep discount mortgages decreases, but it remains a relevant factor. It’s particularly pronounced during periods of considerable rate increases, as we’ve experienced recently.
Jordan:
Let’s talk about the shifting landscape of mortgage rates. How have they evolved in recent years, and what does this mean for homeowners and buyers?
Dr. Patel:
Mortgage rates have indeed shifted significantly. They’re currently hovering just above 7%, a far cry from the sub-4% rates of previous years. This shift has led to a meaningful increase in the share of mortgages with rates of 6% or higher, reaching 17.2% by the end of Q3 2024, its highest point since Q3 2016.Simultaneously occurring,the share of mortgages below 4% has dwindled. For homeowners and buyers, this means higher monthly mortgage payments, reducing affordability and potentially delaying purchasing or refinancing decisions.
Jordan:
What steps can policymakers take to mitigate the impact of the “locked-in effect”?
Dr. Patel:
Policymakers could consider incentives for homeowners to sell, like temporary capital gains tax exemptions. Though, care must be taken not to disrupt the market further. Encouraging new home construction can also alleviate pressure by increasing inventory. Lastly, fostering clarity and creating tools that help homeowners understand and plan for potential rate changes could empower them to make more informed decisions.
Jordan:
Dr. Patel, thank you for your insightful responses. It’s been a pleasure having you on Archyde today.
Dr. Patel:
Thank you, Jordan. It was my pleasure.
