Mortgage rate trap worsens housing market

One major factor that has helped many homeowners save money is ultimately hurting homebuyers. Call it the interest rate trap.

Years of record low rates, especially in the past two years, have helped millions of homeowners refinance into mortgages at rates between 2% and 4%, reducing their monthly payment by hundreds of dollars.

Now that mortgage rates are approaching 5%, those same homeowners are thinking twice about trading, adding to the inventory shortage that is creating an affordability crisis for buyers.

“Existing homeowners act as a deterrent to selling because every dollar borrowed costs more,” Mark Fleming, chief economist at First American Financial Corporation, told Yahoo Money. “The financially sound decision is not to sell.”

This week, the mortgage rate on the 30-year fixed mortgage hit 4.72%, the highest level since December 2018, according to Freddie Mac.

A year ago, this rate was 3.13%. It hit an all-time low of 2.65% in January last year. Meanwhile, millions of homeowners jumped at the chance to snag an all-time low rate.

Now only 14% of homeowners with a mortgage have a rate of 4.75% or higher – which is where Freddie’s Mac measure is roughly now. They’re also the only group of homeowners who could sell their home now and buy another at a rate similar to what they’ve got – if all the deals fall into place before rates go back up, an uncertain feat given that rates rose to the fastest three-month clip since May 1994, per Freddie Mac.

Otherwise, the remaining 86% of homeowners are sitting with a mortgage rate of 4.625% or lower.

“There is a greater disincentive to relocate and replace their current mortgage who likely has a lower fixed rate, reducing housing turnover,” according to a note from BofA Global Research.

86% of homeowners are sitting with a mortgage rate of 4.625% or less. (Credit: Dark Knight)

How big is the deterrence?

Take a homeowner with a $100,000 mortgage at 3%. This homeowner is paying $3,000 a year in interest payments on a 30-year fixed-rate mortgage, Fleming said. If that same homeowner sells their existing home and buys another home for $100,000 at 4%, the homeowner will pay $4,500 per year, which is $1,500 more or $125 more per month.

“So why put my house on the market to sell it and become a buyer right away when it will cost more per month?” said Fleming.

And that’s what happens – potential sellers don’t sell.

At the end of February, housing inventory for existing homes totaled 870,000 units, down 15.5% from a year ago when there were 1.03 million units, according to the National Association of Realtors ( NAR). Existing homes account for 90% of total home sales.

The result?

“I think there’s no doubt that the low inventory of homes for sale is driving up prices – probably the biggest reason,” David Berson, chief economist and senior vice president at Nationwide Mutual, told Yahoo Money.

A house for sale is seen in Washington DC, United States, December 12, 2021. Annual growth in U.S. home prices remained strong at 18 percent in October, the highest in 45-year history of the index, according to CoreLogic& the house price index.  (Photo by Ting Shen/Xinhua via Getty Images)

A house for sale is seen in Washington DC, U.S., December 12, 2021. Annual U.S. home price growth remained strong at 18 percent in October, the highest in 45-year history of the index, according to CoreLogic’s Home Price Index. (Photo by Ting Shen/Xinhua via Getty Images)

The S&P CoreLogic Case-Shiller National Home Price Index posted an annual gain of 19.2% in January, from 18.9% in December.

“While the re-acceleration in house price increases may be concerning and likely disheartening for first-time buyers and younger buyers, it is nonetheless unsurprising given the disastrous inventory of homes for sale, which continues to decline and to continually record new lows,” Selma Hepp, deputy chief economist at CoreLogic, said in a statement.

While a seller would get a good price for their home, buying another one means dealing with rising mortgage rates, rising house exchange prices, and an ultra-competitive market due to low inventory – a vicious circle that continues to deter owners from selling.

“It will slow down both demand and supply,” Berson said.

There is also another factor at play: inflation, especially as housing costs – both rents and sale prices – are skyrocketing.

Housing – mortgage or rent – represents a third of the budget of most households. Even with maintenance costs and rising home insurance premiums, home ownership is still cheaper, as it accounts for only a quarter of housing expenses, according to Fleming. The rest is a fixed mortgage payment.

“Rents are rising faster than inflation in some areas,” Fleming said. “The best protection against inflation is home ownership, because your housing cost stays the same.”

FJ More

FJ More

Ronda is a senior personal finance reporter for Yahoo Money and an attorney with experience in law, insurance, education and government. Follow her on Twitter @writesronda

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