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The Coming Mortgage Lock-in: Future Effects of Today’s Low Rates

Mortgage rates are now the lowest they have ever been, at least in America, and possibly in the world. Today’s low rates will have lasting effects on labor mobility, the demand for new houses and the remodeling industry. The low mortgage rates will make it more expensive for homeowners to move to different homes in the future.

Let’s run some numbers. Recent mortgage rates have been around 3.5 percent, at which rate a 30-year fixed rate mortgage of $200,000 has monthly payments of $898. Let’s say that a young couple buys a house today for $250,000, putting 20 percent down and financing the remainder. After a few years the babies arrive and the couple thinks about a larger house. They may decide that they can afford 20 percent higher mortgage payments, or $1,078 per month. How much house can they get with 20 percent higher monthly payments? If interest rates have moved up just one percentage point, then their monthly payments that are 20 percent higher support a mortgage that is six percent higher. That’s not a lot of improvement for the family.

US 30 Year Mortgage Rate Chart

Suppose that mortgage rates have gone up not one percentage point but two, to 5.5 percent. Then a new mortgage would cost 26 percent more for the same old principal. In other words, it would be very expensive for the couple to move.

Is it reasonable to think that mortgage rates could move up to 5.5 percent? That would leave rates below where they were in the mid-2000s housing boom. Eventually mortgage rates will move up to the average of the 1990s, or eight percent.  At eight percent, that $200,000 mortgage would cost $1,468 a month, 60 percent more than the current cost of a similar mortgage.

How many homeowners would be affected?  A rough estimate is that one-fourth of all families will feel locked in place by rising mortgage rates. (That is based on Zillow’s estimates that 54 percent of mortgagees have equity of at least 20 percent of their home value, and thus would probably qualify for a new mortgage. Many homeowners are underwater, and many more have too little equity to qualify for a new mortgage at today’s low rates. About one third of homes are owned free and clear. There are also about one third of all households that rent—they are not locked in to their current residence by low mortgage rates.

This will have broad implications for business in America. The most obvious is that moving into a larger house will be very, very expensive for these families. Look for homebuilders to have difficulty selling larger houses that would best fit a growing, upper-middle-class family.

With so many families locked in to their current houses, remodeling and additions will be a big business. The desire for more bedrooms, a larger kitchen, and nice cabinetry will be alive, but moving will be expensive, so many families will upgrade their current homes.

Finally, moving for a new job will be more expensive when it means getting a much more expensive mortgage. Companies recruiting executives or technical workers will have a more difficult time luring people to new jobs that require moving to a new home. Let’s say that an engineer has a $200,000 mortgage on her home, and she will move into another house with a similar mortgage. If her interest rate moves from 3.5 percent to 5.5 percent, she will have to pay about $3,000 a year more on her mortgage. It won’t take too large a raise to justify that, but there will likely be a psychological regret about giving up the great mortgage.

The entire nation will probably see a little less labor mobility. People who live in depressed areas are usually more likely to move, and they are more likely to move to rapidly growing parts of the country. Mortgage lock-in will slow the moves.

Mortgage lock-in will not stop new homebuilding, nor will it stop all corporate transfers, but it will have an effect on some parts of the economy that should be understood in advance.

SOURCE: Forbes