This week, the Federal Reserve decided to maintain interest rates and hinted at possible reductions in the not-too-distant future. Nonetheless, the elevated interest rates currently in place may be having unforeseen impacts on the real estate sector. Julia Fonseca, an economist affiliated with the University of Illinois at Urbana-Champaign, pointed out that approximately 60% of those with mortgages had rates below 4% as of March.
In contrast, the typical rate for a 30-year fixed mortgage is now close to 7%. This difference has resulted in what is referred to as mortgage lock-in, where homeowners hesitate to relocate due to nearly doubling their mortgage rates. “Mortgage lock-in remains a significant issue,” Fonseca remarked.
“A lot of individuals are eager to move to a new city or into a larger home, but it’s challenging to part with these low rates.”
Fonseca and her research team explored the impact of mortgage lock-in on the housing sector. They discovered that this phenomenon not only dampens demand—because those in starter homes are opting to stay in place—but also affects supply, resulting in a decreased availability of existing homes on the market. “Thus, you are simultaneously reducing both supply and demand,” Fonseca clarified.
“Consequently, the overall impact on prices has been an upward trend.”
Julia and her colleagues noted that increasing interest rates, intended to temper the economy and curb inflation, are paradoxically driving up home prices by having a more substantial effect on the supply side. “This suggests that increasing interest rates from lower levels to combat inflation may inadvertently generate some inflation through the housing markets,” she stated. Further complicating matters, homebuilders face difficulties in alleviating this supply challenge.
Their business model necessitates borrowing prior to construction, and higher interest rates render borrowing more expensive. The scarcity of starter homes also hinders renters’ progression up the housing ladder.
Consequences of mortgage lock-in
This rising demand for rental properties is driving rents higher. Housing markets in the U.S. exhibit variation, with some regions experiencing housing affordability challenges even before the Federal Reserve initiated interest rate hikes. For instance, the Bay Mills Indian Community in Michigan’s Eastern Upper Peninsula is contending with a micro-housing crisis.
In the last five years, rentals and property values have escalated, pushing numerous middle-income households—earning between $30,000 to $60,000 annually—out of the market. Whitney Gravelle, President of the Bay Mills Indian Community, emphasizes that housing and childcare are critical priorities. With rents for specific one-bedroom apartments increasing from $400 to $1,200 monthly and soaring home prices, many families find homeownership out of reach.
The government of Bay Mills has taken proactive measures by obtaining $880,000 from the state’s “Missing Middle Housing Program” to construct 11 single-family homes. These new dwellings, owned by the tribe, are leased to middle-income families at affordable rates ranging from $400 to $600 monthly. The homes are situated on one-acre plots surrounded by nature, fostering a sense of individuality and community.
“Even though it’s a housing development project initiated by the government, the uniquely colored doors provide a more personalized environment for families,” Gravelle observes. In conclusion, the trend of rising interest rates seems to correlate with increasing home prices, forming a contradictory scenario. Nevertheless, Fonseca stressed that this does not indicate that the Federal Reserve’s monetary policy is ineffective.
On the contrary, it suggests that the Fed’s objective of controlling inflation will be even more daunting due to the implications of mortgage lock-in. The Federal Reserve is set to announce its next interest rate decision in September, and it is uncertain whether homeowners will begin breaking free from their mortgages by the close of this year.
