During the pandemic, historically low interest rates offered a unique opportunity for prospective homeowners. However, research by Lu Liu, assistant professor of finance at Wharton and Julia Fonseca of University of Illinois at Urbana-Champaign, suggests that locking in those low rates may have had unintended consequences.
This paper is a part of the Jacobs Levy Center’s working paper series on SSRN and won the Rodney White Center’s 2023 Marshall Blume Prize for Best Paper.
Professor Liu expands on the economic impact of mortgage lock-in, in the interview below.
Can you explain what mortgage lock-in is, and how it has affected homeowners in the past few years?
Lu Liu: Mortgage lock-in refers to the situation where existing homeowners have locked in a low rate – with the average borrower in the U.S. currently having locked in a rate of 4% – but if they were to move, they cannot take that low rate with them, and would have to take out a new mortgage at market rates closer to 7%, which would substantially raise their total mortgage payments. As a result, homeowners are staying put since moving would come at a significant financial cost to remortgage at higher rates. Because so many homeowners are affected and not selling their houses, housing inventories have dried up, and house prices have remained quite high despite higher interest rates, making it further difficult for first-time buyers to buy a house.
Your study mentions that a 1 percentage point change in mortgage rates can significantly impact peoples’ moving decisions. Why do you think people are so influenced by this difference?
Lu Liu: For the median borrower, a 1 percentage point increase in mortgage rates translates into around $2,000 more in annual mortgage payments, which over the term of the mortgage can amount to an additional $35,000 in future payments. Over the most recent years, we find that a 1 percentage point increase in lock-in (measured as the difference between the locked-in rate and current mortgage rate) thus reduces moving by 16%. This lines up with how valuable the currently low mortgage rates are, and how costly it would be to give them up – we estimate that the value of the low locked-in rate for the average borrower is about $50,000 in terms of total expected future mortgage payments, taking into account future refinancing in case rates come down. This cost deters homeowners from selling their homes and moving, even when doing so might otherwise make sense for reasons like employment or lifestyle needs.
You show that mortgage lock-in can dampen people’s responsiveness to local job opportunities. What does this mean for the broader economy, especially in areas with growing industries?
Lu Liu: Mortgage lock-in reduces geographical mobility by discouraging homeowners from relocating for new job opportunities. We find that more locked-in homeowners are less likely to move in response to wage growth in nearby regions, suggesting that people may not take up higher-paid job opportunities that require relocation. For the broader economy, particularly in areas with growing industries, this could lead to a mismatch between job opportunities and available workers, creating labor market inefficiencies. Industries that are more dependent on talent pools elsewhere and that cannot hire well-matched employees in the local labor market may be particularly affected. The overall mismatch effects will also depend on to what extent people without a mortgage, such as renters, are able to fill those positions.
What role do you think government policy or mortgage lenders could play in addressing the challenges posed by mortgage lock-in?
Lu Liu: The challenge for policy is that most existing mortgage contracts do not allow borrowers to take the rate with them if they move, or sell the house to someone together with the low mortgage rate. These features are called “portability” and “assumability” and offered in many other countries, but are not common in the U.S. (except for FHA/VA mortgages, which come with their own restrictions).
Government policy could improve facilitating renegotiation of mortgage contracts between borrowers and lenders (and likely mortgage servicers) to ease the lock-in effect. The White House has also proposed a $10,000 tax credit for sellers of starter homes, though this may be insufficient compared to the value of locked-in mortgage rates, and may have unwanted spillover effects on house prices. We discuss these issues in more depth in our op-ed on MarketWatch.
What inspired you to explore the relationship between rising mortgage rates and people’s decisions to move or change jobs?
Lu Liu: Interest rates had been broadly declining over the last few decades, so the sharp increase in mortgage rates since 2022, following a long period of historically low rates, created a one-of-a-kind experiment to study the effects of mortgage lock-in. Given that the majority of U.S. households remortgaged or took out record low rates in the years prior, the prevalence of lock-in is also unprecedented – the average borrower is substantially locked in, with potentially large implications for housing and labor markets.
Learn more about Professor Lu Liu.
This research was supported by the Jacobs Levy Center. View the study, “Mortgage Lock-In, Mobility, and Labor Reallocation” on the Jacobs Levy Center’s SSRN page.
Listen to Professor Liu discuss this research on the Ripple Effect podcast.