Rate Lock-In Effect Has Homeowners ‘Imprisoned’ in Their Existing Homes

Despite having gained considerable equity during the past few years, U.S. homeowners are increasingly “imprisoned” in their current homes, due to rising interest rates.

This, in turn, is slowing the housing market, which is normally stimulated by homeowners “upsizing” to larger or more luxurious homes, leaving behind more “starter” homes for first-time home buyers.

According to recent research from First American Financial Corp., the median tenure length for single-family homeowners jumped to 10 years in September, an increase of 10% compared with September 2017.

This is surprising when one considers that U.S. homeowners have, overall, gained considerable equity during the past several years. The perception that home prices have “peaked” has traditionally resulted in homeowners wanting to sell, but not this time around.

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“The recent dramatic spike in tenure length is reflected in the growing performance gap between market potential and actual existing-home sales, which is up 48 percent since the end of 2017,” says Mark Fleming, chief economist for First American, in the report. “Homeowners are staying in their homes longer than ever, limiting supply and slowing home sales.”

Adding to the problem is the fact that housing inventory is at record lows, primarily a result of the fact that new home construction has not been keeping pace with demand.

“While the housing market continues to underperform its potential by 7.2 percent, the gap between actual existing home sales and the market potential for home sales narrowed by one percent in September compared with August, according to our Potential Homes Sales model,” Fleming says. “However, even though the performance gap narrowed a bit, the housing market still has the potential to support more than 440,000 additional home sales at a seasonally adjusted annualized rate.”

First American’s data shows that existing-home sales potentially increased to an annual pace of 6.18 million in September, an increase of 0.9% compared with August and an increase of 3.5% compared with a year earlier.

This represents a 65.4% increase compared with the market potential low point reached in February 2011.

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The annual pace of existing-home sales is now about 15% below the pre-recession peak seen in July 2005.

“The primary culprit for the housing market’s performance gap remains severe supply shortages – home buyers can’t buy what’s not for sale,” Fleming says. “Rising interest rates create a financial disincentive that prevents existing homeowners with low mortgage rates from selling their homes, further limiting supply and restricting existing-home sales from reaching their potential.”

The consensus among economists is that mortgage rates will continue to rise, increasing from the current average rate of 4.9% for a 30-year, fixed-rate mortgage to an average of 5% in 2019, Fleming says.

“The 30-year, fixed rate mortgage hasn’t hit five percent since 2009,” he says. “Homeowners with mortgage rates below the current rate may be reluctant to give them up for a higher rate, a phenomenon known as the ‘rate lock-in effect.’”

“There is less incentive to sell your home if borrowing the same amount from the bank at today’s rates will be more expensive than your existing monthly mortgage payment,” Fleming adds.  “As rates rise, many existing homeowners are increasingly financially imprisoned in their own home by their historically low mortgage rate.”

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