As of recent times, the average rate for a 30-year fixed mortgage stands at 7.17%, whereas the average rate for existing outstanding mortgages in the U.S. is approximately 4.0%. This significant disparity in rates greatly discourages homeowners from selling their current homes and buying new ones at higher rates, thereby stifling housing sales motivation.
In March 2023, the Federal Housing Finance Agency (FHFA) published a working paper titled "The Lock-In Effect of Rising Mortgage Rates," which thoroughly analyzed this phenomenon. The study found that rising mortgage rates led to a reduction of approximately 1.3 million existing home sales from Q2 2022 to Q4 2023. In California alone, existing home sales decreased by 182,490 units during this period.
According to the FHFA's research, almost all of the 50 million active mortgages are fixed-rate, with the majority bearing rates significantly lower than the current market rates. This situation suppresses homeowners' motivation to sell their homes. The report highlighted that each one-percentage-point increase in market mortgage rates above the initial rate decreases the probability of a home being sold by 18.1%.
By Q4 2023, the lock-in effect resulted in a 57% reduction in home sales for properties with fixed-rate mortgages. This equates to around 1.33 million home sales being prevented between Q2 2022 and Q4 2023.
realtor.com
Transitioning from lower to higher mortgage rates results in a substantial increase in monthly payments. For many homeowners, selling their current home and purchasing a new one with a higher mortgage rate is financially impractical.
Life Events: Over time, life events such as having more children or receiving significant job promotions might drive homeowners to sell their current homes and relocate, despite having lower mortgage rates. For some, these personal changes can outweigh the economic barriers.
Decreasing Mortgage Rates: If mortgage rates decrease, improved affordability might attract more homeowners to sell and buy new homes. While homeowners might not trade a 4.0% mortgage rate for a 7.0% rate, they might consider moving if it means taking on a 5.5% rate. Lower rates can reduce transition costs, making moving a more viable option.
Senior economist Ralph McLaughlin from Realtor.com predicts that the trend in mortgage rates is unlikely to break the lock-in effect until at least the end of this year, potentially extending into 2025. He notes that the Federal Reserve's commitment to fighting inflation makes it difficult for rates to decline.
McLaughlin further elaborates, "We may need to see a decrease of 150 to 200 basis points in the 10-year Treasury yield, which could require the Federal Reserve to cut rates three to four times. However, the market expects only one to two rate cuts by the end of this year and two to three cuts by 2025. Therefore, anyone hoping for the lock-in effect to break this year might be greatly disappointed."
The lock-in effect of mortgage rates is significantly impacting the U.S. housing market, reducing the mobility of homeowners and suppressing home sales. As long as the disparity between current mortgage rates and existing mortgage rates remains substantial, this trend is likely to continue. Future shifts in Federal Reserve policy and broader economic conditions will play crucial roles in determining when and how this effect will be mitigated.
