Understanding and Combatting the Rate Lock-in Threat

Today’s low interest rates may be spooking potential move-up buyers. Learn how reluctant sellers are affecting housing inventory and how you can help home owners see beyond the percentage points.

July 23, 2014

For years, a large number of home owners were prevented from moving up because of negative equity. These underwater owners were locked in to their current location thanks to rock-bottom home values.

Now that the economy is improving, those home owners may be moving into the market more freely. But some feel hemmed in for a wholly different reason: They don’t want to give up the rock-bottom interest rate they procured in recent years. This time, however, they’re being locked in by the low interest rates — as low as 3.3 percent in late 2012 — that they secured by buying or refinancing over the past few years. Economists worry this group will be reluctant to move now that interest rates are heading back up, exacerbating an already tight housing inventory.

The Trick of Predicting

Researchers at the Institute of Housing Studies at DePaul University in Chicago say that interest rate lock-in may be more of an impediment to housing turnover than equity lock-in (those who can’t sell because they’re underwater). Their study, published in February, used the Chicago metro area as a test case to predict what rising home prices and interest rates will mean for housing turnover. The study assumed a 1 percent rate increase each year over a three-year period. They found that the number of households freed from equity lock-in by increasing home prices will not offset the number of home owners who are increasingly being locked in by low interest rates. At the end of the three-year period, the turnover rate in strong markets had decreased by 75 percent. The effect in weaker markets was slightly less extreme, but similar.

Though Pat Hendershott, senior research fellow for the study, says the interest rate parameters they set were somewhat arbitrary, rates might actually follow a similar path in the three-year period between 2013 and 2016. National Association of REALTORS® Chief Economist Lawrence Yun predicts that interest rates will increase from current levels (around 4.2 percent) to nearly 5 percent by early next year. He says they will probably rise until they reach 6 percent, then stabilize there. Historically, 6 percent interest isn’t deadly to the economy, but Yun says that a home owner paying about half that may take rates into account when deciding whether or not to move.

“Some home owners will delay moving into a new residence because of the desire to hold on to the current lower rate mortgage,” Yun says.

John Moony, managing vice president of Guaranteed Rate, a national mortgage company based in the Chicago area, says that even a 1 percent increase in mortgage rates can make a big difference in a home owner’s decision-making process. He says a 1 percent increase in interest rates generally equates to a 10 percent reduction in purchasing power. In practical terms, that means a family looking to keep their mortgage payment below, say, $1,500 a month will need to lower the maximum price they can pay for a house from $300,000 to $270,000 if interest rates go up one percentage point.

What Lock-in Might Look Like

It’s hard to know exactly how this will unfold on the national arena, but one CoreLogic executive recently estimated that up to 3.6 million home owners will be reluctant to sell this year because of rate lock-in.

Hendershott says looking back to other lock-in events can provide insight to what home owners might do in the face of interest rate lock-in. He says that historically there has been “a substantial amount of renovation of houses” as home owners seek to put off moving.

But locked-in home owners have a variety of options other than delaying a move, according to Yun. He says some home owners might consider renting out their homes, rather than selling. Others might look into seller financing and assumable mortgages, which can keep the lower interest rates alive while still freeing up the home owner to move to a new residence.

Donna Stadum, ABR, GRI, salesperson with AZ Horizon Realty in Casa Grande, Ariz., thinks rising rates will encourage home owners to get off the fence, at least in the short term.

“Interest rates are still really competitive,” Stadum says. “They’re going to want to move quickly so that they can keep the lower interest rate.”  

It’s About More Than Numbers

The lock-in problem is real, but interest rates aren’t the only calculus people use when determining if it’s the right time to buy.

“Generally speaking, they’re going to make this decision based on what’s right for them, what’s right for their family,” Moony says. “Most customers will make that decision emotionally, but they’ll use the financials to back up that decision.”

Ken Fears, manager of regional economics for NAR’s research department, says that it’s easy for consumers to get caught up in a fluctuating interest rate, but that it’s important for them to make informed decisions based on their particular situation instead.

“I would discourage people from looking at a rate and looking more at the payment,” Fears says. He notes that, if home owners have paid down a large amount of their original loan, the mortgage insurance payment can be released. When they decide to buy a new home, Fears says they may be able to avoid mortgage insurance on the new home by applying the equity and price appreciation they’ve gained to the new down payment (minus transaction fees). ”So even with higher rates and a larger loan, the lower balance and lack of mortgage insurance may offset the higher interest rate. They may have the same monthly payment, but be able to buy more home.”

Two of the main drivers of move-up buyers are school quality and home size. Fears says that while home owners may choose to spend money on a private school or adding on to their current home instead of moving, such expenditures don’t have the tax benefits or equity-building power that a home purchase does.

“They have to decide if the higher cost [of the loan] is enough that it would offset the benefits of a larger home or a better school district,” he says.

Relying on Trusted Advisors

Applying broad trends to the individual situations of buyers and sellers is a nuanced task for mortgage brokers.

“It seems like I’ve never written the same loan twice,” Moony says. “Every customer is different [and] every property is slightly different.”

Real estate professionals are not only there to help home owners decide if it’s the right time to move up, but also to connect potential clients with accurate, up-to-date mortgage information. Stadum keeps an eye on the mortgage market in her area, but she also relies on her contacts in the financial world for analysis.

“I don’t follow it on a daily basis because I’m not a lender. I’m a real estate agent,” Stadum says. “I’m a firm believer that a real estate professional should be the source to the resource.”

She depends on a couple of lenders for interest rate updates, as well as information about pending changes to loan programs that are popular in her area, such as the U.S. Department of Agriculture Rural Lending program.

“Anytime that was coming up for a new vote, that was a big topic,” she says. “What’s happening with the USDA? Are we keeping it? What new loan programs are coming up, and what are the credit requirements? I ask those types of questions.”

Moony agrees that strong ties between real estate professionals and lenders are key to helping home owners determine the best time to make a move.

“It’s really important that customers and real estate agents are getting sound advice,” Moony says. He also recommends that real estate pros stay in touch with trusted mortgage advisors and connect their clients with financial professionals early on: “They should have a couple of lenders that they work closely with [and] they should get that buyer to a lender before they even look at houses.”

Despite the uncertainty to come about the lock-in situation, Stadum says there’s one thing that’s almost a given about today’s interest rates: “Interest rates are still really low… But they’re not going to be at these record lows forever.”

Meg White

Meg White is the former managing editor of REALTOR® Magazine.