How households are locked in by rising mortgage rates
A new paper co-authored by Wharton’s Lu Liu looks at why homeowners become caught in a so-called ‘mortgage lock-in’ and how that impacts their ability to move.
The steep increase in interest rates over the past year has lifted housing mortgage finance rates as well. For most people who bought their homes when interest rates were at historically low levels over the last 15 years, refinancing their mortgages at today’s higher rates is a losing proposition. Those homeowners are caught in a so-called “mortgage lock-in,” according to a new paper titled “Mortgage Lock-In, Mobility, and Labor Reallocation” co-authored by Wharton finance professor Lu Liu.
Lu Liu, assistant professor of finance at The Wharton School.
(Image: Courtesy of Knowledge at Wharton)
Typically in the U.S., a homeowner with a mortgage can move to a different home only after paying off the existing mortgage and refinancing their home with a new mortgage. But homeowners who find themselves in a mortgage lock-in cannot move to a different location unless they buy a cheaper home or earn more, in addition to covering the costs of moving and refinancing. In such conditions, Liu says “the housing market is gridlocked,” where homeowners have a “strong incentive to stay put” in their current homes.
The paper’s authors build their case around the metric of the mortgage rate differential (or “mortgage rate delta”) which is the difference between the mortgage rate locked in at purchase and the current market rate. Their study covered the period between 2010 and 2018, with about four million observations (or households) of data on consumer credit records. The average mortgage loan balance was $205,480, the average remaining loan term was 21 years, and the average mortgage rate was 5.1%. The moving rate was measured as a change in a homeowner’s primary residence that has been reported to a credit bureau or bank.
According to Liu, their paper offers some takeaways for policymakers. She points out that when homeowners in the U.S. want to move, they have to settle their existing mortgage and take out a fresh mortgage for their new home. In that, they have less flexibility in moving home than those in the U.K. or Canada, which allow portability (taking your mortgage to a new house) or assumability of mortgages (taking over the mortgage on an existing house), respectively.
“When policymakers raise interest rates, we need to think about mortgage market policies that alleviate lock-in, otherwise there will be knock-on effects on mobility and labor reallocation,” Liu says. It would be helpful if homeowners can keep their existing mortgages and take it to their new houses; policymakers should evaluate these policies with mortgage lenders, she adds.
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