The mortgage-rate lock-in effect.
It’s finance speak for homeowners knowing a good deal when they have one.
With 30-year mortgage rates having dropped below 3% as the Federal Reserve forced short and long-term rates to artificially low levels for more than 20 years, housing markets are now grappling with the hangover effects of that stimulus. One of those effects is the mortgage-rate lock-in effect.
For Americans with mortgage rates at or below 4.00% (six in 10 of us, according to Freddie Mac), the interest savings on a low-rate loan has a behavioral effect: it keeps homeowners where they are, in their current homes, reluctant to leave the sweet deal of a 3.15% loan. Rather than considering moving to a new city or just over to a new neighborhood with rates above 7%, homeowners, both in New Mexico and nationally, have stayed put. In a big way.
The effect of those mortgage holders staying in their homes is constraining the supply of existing homes nationwide. The lock-in effect “is the largest ever in U.S. history and is likely to impact the housing market for years to come,” writes Freddie Mac in its Economic, Housing, and Mortgage Market Outlook for July 2023, which cites the following example to illustrate the effect. “Suppose a lucky homeowner has refinanced their mortgage of $250,000 at 2.65% in January of 2021. Their current monthly principal and interest payment would be $1,007 and after 29 months of payment their current outstanding balance would be $236,379. If the borrower obtained a new 30-year mortgage of $236,379 at the prevailing market interest rate of 6.81%, their monthly payment would increase to over $1,500 a month. The value of mortgage rate lock-in is $86,136 in this example.”
For the average 15- or 30-year loan in Freddie Mac’s portfolio in Q2 of 2023, the holder saves upwards of $55,400 over the life of the loan versus an equivalent deal at today’s rate, as shown in the chart below (the far-right bar). This is just for the average mortgage holder! $55,400 of lock-in effect is a powerful disincentive to moving!
Look at the same chart and you’ll also note that in Q4 of 2020, when rates were at all-time lows, the average holder of a loan in Freddie Mac’s portfolio would have sacrificed $23,200 in interest savings by not moving or refinancing.
Homeowners are choosing, for now, not to leave savings like this on the table. But with these constrained existing-home supplies, new home construction is apparently surging to fill the gap. The demand remains, after all! This development is reflected in the Santa Fe market. Lot sales have grown meaningfully over the last few months. For May, June, and July 2023, bare lot sales rose 11.36%, 10.71%, and 36.59% respectively over the year-ago period.
Buyers, however, may benefit more from balanced Markets. In Santa Fe, we’re no longer seeing quite as many one-sided, risky purchase contracts written with inspections waived, multiple bids above asking price, and other provisions that prove unfavorable to buyers. Some balance has returned.
So, while mortgages with a 7% handle may seem a bad thing, higher rates may save buyers from having to overpay for a property in a transaction laden with excess risk. it’s important to note that the potential reduction of risk and greater negotiating leverage may exceed, in dollar terms, the negative effect of higher rates. That may be evident in negotiations.
So while we all grew accustomed to the thrill of artificially low rates which were a product of forceful Fed stimulus, more normal rates have returned leverage to the buyer, and that’s a good thing.
Read the full Freddie Mac story below.
Sources: Freddie Mac Economic and Housing Research Group, Santa Fe Association of Realtors
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