CALCULATEDRISK
By Bill McBride
Last week I wrote about some homeowners “locked in with golden handcuffs”:
There are always people that need to sell due to the so-called 3 D’s: Death, Divorce, and Disease. Also, in certain times, some homeowners will need to sell due to unemployment or excessive debt (neither is much of an issue right now).
And there are homeowners who want to sell for a number of reasons: upsizing (more babies), downsizing, moving for a new job, or moving to a nicer home or location (move-up buyers). It is some of the “want to sell” group that has been locked in with the golden handcuffs over the last couple of years, since it is financially difficult to move when your current mortgage rate is around 3%, and your new mortgage rate will be in the 6 1/2% to 7% range.
But time is a factor for this “want to sell” group, and eventually some of them will take the plunge.
Here is new working paper from Federal Housing Finance Agency (FHFA) staff Ross M. Batzer Jonah R. Coste William M. Doerner Michael J. Seiler quantifying the impact of the “lock-in effect”: The Lock-In Effect of Rising Mortgage Rates
When modeling financial decision-making, personal and market frictions are commonly assumed away, but in reality, people are often “locked-in” or constrained to remain on their current path because the cost to change course is prodigious. Whether it is continuing to hold a low basis stock to avoid a high taxable sale or avoiding portfolio rebalancing in the face of tax law changes to the treatment of dividends or capital gains, these lock-in effects play a major role in forming financial preferences (Dai et al., 2008; Eilbott and Hersh, 1976; Holt and Shelton, 1962; Kiefer, 1990; Landsman and Shackelford, 1995). This is even more pronounced with residential real estate, where the financial asset is physically stationary and transaction costs are at their highest.
During the Great Financial Crisis (GFC) of 2008, many borrowers could not afford to move because they had negative equity in their homes and a capital budgeting constraint that prevented them from paying off their outstanding mortgage balances, which is necessary to clear the title (Bernstein and Struyven, 2022; Foote, 2016; Ferreira, Gyourko, and Tracy, 2011; Farber, 2012). Several states, like Florida and California, have implemented wellmeaning policies that cap property tax increases for a primary residence to avoid homeowners being priced out of their homes due to rapid home price appreciation that outpaces income growth. Such policies work in the sense that they allow owner-occupants the ability to match their slowly increasing income levels to an artificially stagnant tax increase. However, over time, the difference between what the homeowner pays if they remain in that home compared to what they would pay on a comparably priced different home becomes a true impediment to moving (Ihlanfeldt, 2011; Wasi and White, 2005).
Home equity and property taxes are not the only characteristics of homeownership that create a lock-in effect. So, too, does an environment of rising mortgage rates (Fonseca and Liu, 2023; Liebersohn and Rothstein, 2023; Qiugley, 1987; Quigley, 2002). In the U.S., 96% of borrowers have a fixed rate mortgage, and 63% of those borrowers have a fixed rate below 4%. Given that current rates remain close to 7%, many in-place borrowers simply cannot afford to sell their home because they would be giving up roughly $500 a month in lower mortgage payments worth over $60,000 in present value.1 The aggregate present value across all active fixed-rate mortgages is nearly $3 trillion.
And here is their conclusion:
This paper finds that for every percentage point that market mortgage rates exceed the origination interest rate, the probability of sale is decreased by 18.1%. This mortgage rate lock-in led to a 57% reduction in home sales with fixed-rate mortgages in 2023Q4 and prevented 1.33 million sales between 2022Q2 and 2023Q4. The supply reduction increased home prices by 5.7%, outweighing the direct impact of elevated rates, which decreased prices by 3.3%. These findings underscore how mortgage rate lock-in restricts mobility, results in people not living in homes they would prefer, inflates prices, and worsens affordability.
emphasis added
Over time the lock-in effect will fade, but this is still impacting supply. Here is graph based in data from Altos Research showing single-family inventory is increasing, but still well below normal levels.
The red line is for 2024. The black line is for 2019. Note that inventory is up more than double from the record low for the same week in 2022, but down 38.5% from the same week in 2019.