Something very unusual has happened in the U.S. housing market over the past two years, with mortgage rates rising to about 7%.
Interest rates this high are not historically surprising. The problem is that the average American household with a mortgage sits on a fixed interest rate that's a whopping 3 percentage points lower.
The sharply widening chasm between these two lines is creating a nationwide lock-in effect on a scale not seen in decades, paralyzing people in their homes who want to leave. . For homeowners who aren't looking to move anytime soon, the low interest rates secured during the pandemic will benefit them for years to come. But for many others, these interest rates have become a complex issue, disrupting both household budget decisions and the housing market as a whole.
In fact, this lock-in effect will reduce U.S. home sales by about 1.3 million units during the period of rising interest rates from spring 2022 to the end of 2023, according to a new study by economists at the Federal Housing Finance Agency. This is an impressive figure in a country where in normal times around 5 million homes are sold a year, most of them to people who already own them.
These trapped households are not migrating for better jobs or higher wages, nor are they able to downsize or acquire more space. They also don't open their homes to first-time buyers. And that drove up prices and disrupted the market.
Another way to express how unusual this situation is: From 1998 to 2020, more than 40 percent of American mortgage holders had fixed interest rates that were at least one percentage point below market conditions. There has never been an era. As the graph below shows, by the end of 2023, approximately 70% of all mortgage holders will have their three This is many percentage points lower than what the market would offer if you were to take out a new loan.
Of all the stories this photo tells, the biggest one it captures is the impasse in the housing market, which may be causing widespread dissatisfaction with the economy.
To illustrate how we got here, let's look back in time at the distribution of interest rates held by all American homeowners with fixed-rate mortgages.
In the late 1990s and early 2000s, at the beginning of the timeline covered by the FHFA analysis, most homeowners had a homeownership rate of about 7 to 9 percent. Interest rates then fell due to the dot-com bust and fell even further as we emerged from the Great Recession. Many homeowners also refinanced along the way.
Interest rates then bottomed out at historic lows early in the pandemic, giving many households a bargain of less than 3%.
For most of this period of generally low interest rates and regular refinancing, most homeowners were able to maintain interest rates that were not that different from what they would get on a new loan (within 1 percent or so). I did. If you had set your mortgage interest rate higher than the market, it would have been relatively easy to move or refinance. Even if you have a lower value, the difference is rarely large enough to deter people from changing their homes.
But things have changed dramatically over the past two years as the Fed battles inflation and interest rates on all types of loans have soared.
It may seem strange to suggest that there is now a problem with so many people getting great home deals during the pandemic. The problem arises from the fact that interest rates were very low and rose very quickly after the pandemic. Seemingly overnight, most American homeowners with mortgages have found themselves in a situation where they may feel financially unwise to sell their home.
“You can think of a fixed rate as an asset that you own,” says Julia Fonseca, a professor at the University of Illinois at Urbana-Champaign.
And during this period, that asset has never been more valuable than it is now.
Professor Fonseca estimates that for the average mortgage holder, a fixed rate is worth around $50,000. This is roughly the additional amount people would have to spend if they exchanged their remaining payments on their current mortgage for a higher payment at the current interest rate.
Put another way, FHFA researchers estimate that this difference will be worth about $511 per month to the average mortgage holder by the end of 2023. This is enough to influence household decisions and send shockwaves through the housing market.
“These are real families who are not optimizing their housing,” said FHFA economist Jonah Coste, who worked on the study.
The ripple effect has already been revealed in other studies. Economists Jack Liebersohn and Jesse Rothstein found that mobility rates among homeowners with mortgages declined in 2022 and 2023, but No comparable decrease in migration rates was observed. without it For mortgages or renters.
University of Pennsylvania professors Fonseca and Liu Liu also found that homeowners who are more likely to be housebound are less likely to move to neighborhoods with higher wage growth. This suggests that distortions in the housing market could cause problems in the labor market, ultimately preventing companies from hiring the right workers or preventing further wage increases.
All of this is not simply due to today's high interest rate levels, but to the specific series of events that led us here.
“Nothing like the past four years has happened,” Professor Rothstein said.
Some of these effects may sound similar to the years after the 2008 housing crash. At this time, another issue, underwater mortgages, trapped many people in homes they wanted to let go of. But today's challenges may last longer. That's because 30-year mortgage rates are locked in for 30 years, and it's unlikely you'll see rates below 3% again anytime soon.
President Biden noted how unsettling this is for many people. In his State of the Union address last month, he directly addressed those worried about interest rates. “If inflation continues to fall, mortgage rates will also fall,” he said.
But while many Americans wait, he offered new buyers and their sellers a temporary tax credit worth up to $10,000. The White House points out that for first-time buyers who are making the psychologically difficult mortgage calculation at home, for a median-priced home, this equates to lowering interest rates by more than 1.5 percentage points over two years. ing.
But for homeowners who have been reluctant to sell in the past, this amount is far less than the $50,000 that is essentially the value of a fixed rate for a typical mortgage holder.