Locked-in low mortgage rates will not dissuade today’s homebuyers from selling later
Contrary to conventional wisdom, low mortgage interest rates locked-in by today’s buyers will not dissuade them from selling in the future.
Housing economists point to the specter of rising interest rates as a deterrent to future move-up home sales, reasoning that the higher cost of ownership will provide a strong disincentive for move-up buyers to list and sell their homes. The idea rests on a faulty hidden assumption: that house prices will be higher when mortgage rates rise. Further, the idea fails to consider the equity-building power of loan amortization. Homebuyers are unprepared for reality of rising interest rates, but so are housing economists.
Today’s buyers who are locking in low mortgage rates will set the prices in the move-up market five to seven years from now. If mortgage rates are higher, which seems likely, then the cost of ownership will also be higher. Unless we have significant wage growth, future buyers will not be able to bid as high, and home prices will be lower than most anticipate. (See: Higher prices and rising interest rates will slow housing market appreciation) Even if prices do manage to move higher, move-up buyers will still be able to participate because they will have more equity from the sale of their current home.
Assuming house price appreciation is tepid, the move-up price will not be much higher than current pricing. So where will the equity come from to make a move-up?
Low interest rate loans amortize much more quickly than high interest rate loans. Even if the move-up buyer only sells for enough to cover the transaction costs, they will still have a significant amount of equity to put 20% or more down on a move-up sale, and since they will stretch their amortization from the 25 to 23 years remaining on their old mortgage, between the amortization equity and the extended amortization schedule, they will be able to complete the move-up trade.
Kris Hudson, Jun 13, 2014
Historically low interest rates likely will haunt the U.S. housing market by deterring homeowners from selling in future years after rates rise, housing economists say.
This will be a classic example of being right for the wrong reasons. Higher mortgage interest rates lead to lower sales or lower prices, and if prices are pushed too high, lower sales are very likely. The reason for the slower sales will be the high prices, not any reluctance on the part of sellers to list and sell their homes.
Economists theorize that, in the so-called rate lockdown effect, homeowners that landed mortgages in recent years with rates 3.5% to 4% might be reluctant to sell their homes in the coming years, which would cause them to forfeit the rock-bottom rates on their existing mortgages. Rates for 30-year, fixed-rate mortgages, now at 4.2%, are widely forecast to reach 5% by next year.
Quantifying the potential drag on home sales from the lockdown effect is challenging,
It’s challenging because the idea is completely erroneous.
but economists speaking Friday at a Houston conference of the National Association of Real Estate Editors said some type of effect is almost guaranteed.
Stan Humphries, chief economist for real-estate website Zillow, projects that an increase in rates to 5% will cause a 5% decline in existing home sales from current levels. A rise to interest rates of 6% will cause an 15% decline in sales, he predicts.
Stan Humphries is right because higher mortgage rates will make houses less affordable, assuming prices don’t come down to accommodate the reduced borrowing power.
“We’ve locked all of these people into these low rates, mostly in 30-year fixed mortgages,” said Mark Fleming, chief economist at real estate data firm CoreLogic Inc.CLGX -0.16%, at the conference. “There’s a huge disincentive … to sell at any point in the future. My expectation is that housing turnover rates will be down significantly in the future due to this rate lockout effect.”
Earlier this year, researchers at DePaul University’s Institute for Housing Studies in Chicago issued a paper on the lockdown effect. Their projection: Even though rising prices in recent years have brought more home sellers into the market, any steep rise in interest rates likely would nullify that influx by causing more homeowners to want to stay put and thus keep their low interest rates.
Another potential effect of the lockdown effect: An increase in novice landlords. Some economists say homeowners who must move might opt to hang onto their former home and rent it out to keep the low interest rate on the mortgage.
“We have more everyday folks becoming unplanned, accidental landlords in the future because they don’t want to give up their 3.5% rate,” said Lawrence Yun, chief economist for the National Association of Realtors.
We have an entire generation of unplanned landlords due to the housing bust. This is not some new or recent phenomenon caused by today’s low rates.
Rate increases are a near certainty in the next two years. The Federal Reserve has held rates historically low in recent years to spur a recovery in the economy after the severe economic downturn. As the economy slowly rebounds, the Fed is rolling back its stimulus efforts with an eye toward eventually increasing its benchmark interest rate, the fed funds rate, from historically low levels.
When mortgage interest rates do rise, we will see a resurgence of loan assumability among buyers with FHA loans. This will provide plenty of buyers who can participate in the move-up market.
The bigger question is what will rising rates do to home prices. Everyone assumes house prices can never go down again, particularly with the success of recent can-kicking efforts from lenders; however, there are many reasons higher mortgage interest rates may hurt future home prices. The accelerated amortization of today’s low interest-rate loans, FHA assumability, future income growth, and extending the amortization schedule will provide the impetus to keep the move-up market alive, albeit far less robust over the next decade than in times past.