Wharton’s Lu Liu discusses what policy changes may be needed to break mortgage lock-in, which is restricting real estate inventory in the U.S. housing market. This episode is part of a series on “Real Estate.”


What’s the Current State of the U.S. Housing Market? 

Dan Loney: Within the housing market, there has been something called mortgage lock-in. It started during the pandemic when we saw mortgage interest rates sink to down around 3%. But now we see mortgage rates more around 7%. In many cases, people who had that 3% rate don’t want to give it up for a new home where they’re going to have to pay 7%. That brings an interesting dynamic to the housing market as we move forward.

With me is Lu Liu, who is an assistant professor of finance here at the Wharton School. Lu, this is such a unique dynamic. When this first happened, it almost felt like it was opening a door to opportunity for so many homeowners back a couple of years ago.

Lu Liu: The low rates certainly did, right? There’s an image that’s been going around of mortgage lock-in as “golden handcuffs.” The fact that you’ve got a 3% rate locked in is good for you. It’s golden, right? It’s a golden thing to have. But the issue that we’re discussing today is that it also locks you into your current house, so people have not been moving. They’ve not been selling their houses, and that can lead to issues down the line, as we see today.

Loney: That can have an impact not only with the individual who owns the home, but when you think about, maybe they’re not changing jobs, not moving. That has an impact on companies.

Liu: Absolutely. It has an impact possibly on firms and hiring and moving. It also has an immediate impact on the housing market itself. As somebody with a 3% rate locked in, you don’t want to put your house up for sale. But the market functions much better when there is a constant coming and going of inventory up for sale, so that other people who want to move to where you live can also move there. We’ve not seen that. Housing transactions have dropped by 30% relative to last year. Housing transactions have fallen off a cliff. They’re at great financial crisis levels, meaning that new homebuyers, as well as people who would like to move, actually find it very difficult to find a house that’s up for sale.

Loney: How do we turn that around and get us back towards a more normal housing market, where you have a lot of that transactional movement?

Liu: That’s a great question and challenge for policymakers today. If you remember the State of the Union Address, the Biden Administration — because they saw it as such an issue that first-time buyers cannot enter the housing market — proposed a $10,000 tax credit to people who own starter homes. That’s defined as people who own relatively low-priced homes in a given county.

When we looked at that proposal, I think one challenge is that there is basically a housing ladder in the housing market. If you own a starter house, and the Biden administration gives you $10,000 to sell it, you need somewhere else to move. If you’re in a starter home and you want to expand, you may be moving into a more expensive or a larger house. You are likely to buy from someone who is likely also locked in, also got a 3% mortgage, so how are you going to convince them to sell to you? Maybe you’re going to agree to pay a higher price, so part of that tax credit is going to go to people with larger homes. That’s one way to split it.

The other challenge is that we think $10,000 is probably not large, relative to how valuable the low rate is for you. We estimate that for the average U.S. mortgage borrower, the fact that you’ve got a 3% or 4% rate locked in on average is worth to you about $50,000. So, $10,000 is maybe not enough to convince one person to sell, let alone two. That’s one challenge.

Obviously, we’re also not saying you should just raise the tax credit and just throw money into the housing market. These kinds of subsidies can be inflationary by themselves. There’s an additional challenge with policy trying to stimulate the housing market without causing inflation, which would be entirely counteractive because that would cause rates to stay higher for longer and lock people in for even longer. There’s a real policy conundrum.

How Much Does Inflation Affect Housing?

Loney: How much do you think inflation has played a role into this? There’s also the component of the price run-up we’ve seen in properties over the last couple of years. People who had a house valued at $300,000 pre-pandemic probably saw between $50,000 and $100,000 in extra value in just a couple of years.

Liu: That’s right. There have been pandemic factors in the past that I think have led to an increase in inflation. Going forward, the challenge for monetary policymakers is the idea of raising rates, which is why mortgage rates are so high today. The goal was to dampen inflation. But what we just discussed, these are in the labor market as well as in the housing market. These are actually two factors caused by lock-in that may, if anything, be inflationary. We’re not putting our houses up for sale. We’re also not buying. But it seems the lack of liquidity and inventory seems to generate upward price pressures, so house prices have remained really remarkably high, given that rates are so high. Maybe you have to compensate, for instance firms and workers, in order to move. Maybe you have to offer part of the compensation package. You may have to entice someone to pay a bit more. So, I think there are risks around lock-in where the policy has raised interest rates, but actually there may be effects that are inflationary coming through lock-in.

Loney: What’s interesting right now is we’re looking at rates at around 7%, and I think people are trying to figure out where that sweet spot is that will really start to drive activity. Do you need to get rates on average down closer to 6%, 5.5%?

Liu: I don’t think there’s a magic number, even though maybe people have these kinds of thresholds in mind, like, “I’m waiting for it to hit 5%.” What we would say as economists is basically it’s very difficult to time exactly when rates come down. They may stay higher. That’s been a surprise in the latest inflation news, so you should make your decisions based on your personal circumstances.

Typically, there’s an option to refinance if rates come down. Even if you had to take out a mortgage rate today at higher rates, you can refinance down. Obviously, there’s a cost involved with that, and you have to make sure that there are no prepayment penalties, so that’s maybe more practical advice. But you should definitely not try to time the market. I think that’s very difficult to do, given that we don’t see a super clear path.

Loney: The location has to be a factor as well. When you think about the value of a home in Montana or Utah or North Dakota, it’s going to be a lot different to what we see here in Philadelphia or New York or Chicago. If there is an incentive put forward by the government to try to ease this lock-in, is it better to have it at the federal level, or do you need to have some combination with the state and local governments because of that difference in value?

Liu: That’s what we’re hoping to tackle, and new research has tried to model the housing market with this kind of housing ladder and different types of housing and different prices in different regions. You may have to really finely calibrate any such intervention. An alternative intervention that we also want to highlight and push and promote going forward is there are actually ways in which you can unlock the market through a mortgage contract. In some countries, it is actually possible to take your mortgage with you when you’re moving.

Loney: Take the rate with you?

Liu: Take the rate with you, exactly. The friction right now in the U.S. is that as a U.S. borrower, you would ideally want to go to your bank and maybe renegotiate and ask them for you to port the mortgage or maybe take some part of the rate — keep some of that with you as you’re moving. But that’s typically not possible because mortgages are securitized and sold to mortgage-backed securities investors, so you typically end up negotiating with the mortgage servicer. There has been some evidence following the financial crisis, in some key studies these days of how difficult it is — they typically don’t have to write incentives to renegotiate. Really there’s not that much in it for them.

I think if the government were to step in, it could certainly incentivize, maybe provide some benefits in terms of allowing servicers to renegotiate.

How Is Mortgage Lock-in Impacting the U.S. Housing Market?

Loney: On the component of relocation, or the lack thereof because of the mortgage lock-in, where do you think are the biggest impacts that we’re seeing?

Liu: In our research, we certainly found that moving far away and across states is a little bit more affected by mortgage lock-in. Part of it could be that maybe the benefits of moving far away are a little bit more uncertain. You have to maybe take your entire family with you, and there is uncertainty around that. Giving up something for sure, which is your low rate, for something that is much more uncertain in the future, like a better-paying job that’s going to pay you a lot more money into the future, but maybe that’s difficult to trade off with the low rate that you have right now.

That could certainly have medium and longer-run effects on productivity, on firms being able to hire the right workers, and obviously the kinds of opportunities that people take.

Loney: Would you think that labor market situation would be somewhat cyclical, that we’re going to work our way through this as we move forward?

Liu: If you look at the aggregate data, we don’t see a lot of evidence of that, that people have trouble hiring, and the labor market has been quite strong. We haven’t seen it in the immediate data, so a question for the economy whether this will have maybe more medium-term detrimental effects will depend on whether a given worker was locked in is very difficult to substitute. And that may differ very much across different industries.

Maybe you have very, very particular skills, but you’re not willing to move. Then a firm that really requires your skills will have trouble and may do worse as a result of that. On the other hand, if most people who are locked in can be replaced by people who are renting or by people who are still mobile, who don’t have a mortgage, then maybe the aggregate effects are a little bit more muted. I think the jury is very much still out on that labor reallocation.

Loney: Does the question around lack of inventory factor into this as well?

Liu: I certainly think so. As I was saying earlier, the fact that an individual does not put their house up for sale basically causes these ripple effects for other people who depend on the market being liquid, and that certainly can affect people’s ability to move to a certain place, to find the right house or maybe certain types of housing, as single-family housing may be particularly difficult to obtain, and that’s what you need if you want to relocate for a job far away. We think of that as an important externality, which is why policy should look into it in the first place instead. These are not individual decisions that the individual can resolve. they may actually affect lots of other sellers and buyers.

Loney: We’ve been in this mortgage lock-in for a couple of years at this point. Is this going to have longer-term effects in the housing market?

Liu: Most of these households have locked their rates in for 30 years, so technically they could stay in place and keep their 3% mortgage for up to 30 years. The potential of having long-run effects is certainly there, and what we’ve seen over the last year, towards the end of the last year, there was a lot of enthusiasm — I think slightly unwarranted — and a push for lower rates, given that inflation had subsided. But I think, if anything, some of the markets that we’re seeing today may point to some upside risks for inflation. So, I think it’s very difficult to predict how long interest rates are going to stay high.

While that’s happening, people are basically in this gridlock. They are kind of waiting, and maybe not wanting to let go of these currently low rates, and that obviously causes a little pent-up demand. House prices are high, in particular for first-time buyers and families want to own a house. That obviously pushes back all of their life decisions in a way. The longer that subsides, every month and year will count, because this is going to be like pent-up demand and distortionary effects that could be quite large for many people.

Loney: There’s also the fact that younger generations are waiting longer to buy that first home.

Liu: That’s certainly what people have said, that during the pandemic, a lot of people, for instance, moved in with their parents to save for a down payment. There is actually a huge cohort of people who are looking to buy and looking to buy a house for the first time. They are forming a new household because they’ve saved for a down payment. They’ve entered a market that had high prices, high mortgage rates, and low inventory.

I think there’s a general sentiment that people are upset about this constellation. It’s basically like facing a triple set of challenges, which is why I think policymakers wanted to signal with the State of the Union Address that they heard people were facing these issues. But obviously the question is: How do we design these policies to actually be effective?