Reviews | A generation of homeowners encounters a strange new market

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As recently as March, a 30-year fixed mortgage seemed like a pretty good deal. The average interest rate was below 4%, even though inflation was more than double.

This divergence could not last forever, and it did not. Just last week, mortgage rates jumped more than half a percentage point, ending at 5.78%. This is the biggest one-week increase in more than three decades, and it will push the housing market into uncharted territory. Buyers, sellers and the Federal Reserve are all going to have to learn to navigate this strange new landscape.

Most American homeowners have only known a world where mortgage rates were generally steadily falling — rising slightly when markets crashed or the Fed got choppy, but still falling over time. Rates hit an all-time high in the early 1980s, when Fed Chairman Paul Volcker dramatically reduced the money supply to bring America last great inflation to a standstill. After that, however, came a long downtrend that accelerated after the financial crisis, thanks to ultra-loose monetary policy that the Fed never really unwound even after the economy recovered.

Now suddenly we’re seeing the kind of push that hasn’t been seen since the 1970s. Rates are thankfully still lower than they were then, but they’re rising fast – they’ve more than doubled since January 2021. The last time mortgage rates were this high was in late 2008, meaning nearly 15 years of homebuyers likely got a better deal than what is now available.

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Some of these people would no doubt like to move – to downsize or increase in size, to bring growing kids to a bigger yard or better school district, to shorten their commute, or to add an actual home office. But mortgage rates complicate this decision.

Take an average middle-class household with a $240,000 mortgage on a $300,000 home they bought in 2018. If homeowners have decent credit and refinance at 3% during the pandemic, they would have a payment of approximately $1,000 per month. If that family is now moving to a house at roughly the same price, their new monthly payment will likely be just over $1,400.

Those who have money to spend will move anyway, as will those who really need it; if your new job requires you to be in California, you’ll sell the New Jersey house and take the damage. But many who come want to moving will likely choose to stay put, instead.

A 2012 paper by economists Fernando Ferreira, Joseph Gyourko, and Joseph Tracy estimated that “for every additional $1,000 in mortgage debt servicing costs, mobility was about 12% lower.” The homeowners in the example above would see an increase in their debt service of nearly $5,000 per year.

Now, not all households will find themselves in this position. Older households often paid off their mortgage as a down payment or a refund; others will have adjustable rate mortgages or older loans at higher rates that they weren’t able to refinance for one reason or another. Still, the effect is likely to be large – and that means we face not just falling house prices, but falling homeowner mobility.

The last time the United States faced this kind of “lock-in” dynamic, in the 1970s, the effect was mitigated by a feature few mortgages have today: the ability for a buyer to “assume” the loan from the current owner, taking on the payments with the property. Since buyers would pay a premium for a property with a low-interest loan, homeowners could monetize their lower rate and use that money to help finance a new purchase.

Banks, of course, didn’t like to sit on those old low-rate loans when inflation drove up the rates they had to pay on savings accounts, so they started inserting “due on sale” clauses that pretty much ended the assumable mortgage. Government loans made through Veterans Affairs, the Federal Housing Administration, and the United States Department of Agriculture still offer this option, but they represent only a relatively small fraction of outstanding loans.

This will make life difficult for owners, of course, and for employers trying to attract desirable employees from distant locations. But it will also complicate the life of policy makers, who cannot easily predict the effects of their interventions on a key sector like housing. This will make it more difficult for the Fed to stage the soft landing we all hope for.

And this, in turn, is just one example of a broader challenge for policy makers and ordinary citizens. The best comparison we have for where we are today is to the 1970s, but the economy has changed in all sorts of ways since then.

Taxes and government benefits are indexed to inflation, which exacerbates inflationary pressures. More people now work in services, fewer in capital-intensive and heavily indebted manufacturing. Larger parts of the economy are exposed to trade, which means being subject to the actions of other governments and central banks. And as noted above, we are now more than a decade into an unprecedented Fed balance sheet expansion, which has undoubtedly contributed to inflation – and will limit the Fed’s options if we end up in a recession.

So, as familiar as this may sound to those of us with memories of the 1970s, we are actually on new ground. And unfortunately, no one has a good roadmap telling us exactly what’s next.

About Daisy Rawson

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