What Is the Mortgage Rate Lock-In Effect?

Those looking to buy a home, along with existing owners, may be familiar with the recent term “mortgage rate lock-in effect.”

This is a relatively new phrase that has come about due to the ultra-low mortgage rates available in 2020-2022.

During those years, it was entirely possible to keep the 30-year fixed limit in the 2-3% range.

In fact, some lucky homeowners can even get their hands on mortgage rates starting at 1.

Here’s the problem – now that rates have doubled, many of these landlords don’t want to give up their low rates. Or maybe worse, can’t.

What is the mortgage rate lock-in effect?

In essence, the mortgage rate lock-in effect is a phenomenon where borrowers are essentially trapped in their homes because of very cheap mortgages.

It’s not a negative at all, assuming they like their assets. But it has been called “golden handcuffs” because it can be somewhat bitter sweet.

Basically, those with 2-3% mortgage interest rates know they have an amazing deal on their hands.

But if and when they sell, they will lose that incredible rate. And worse, if they buy another home and finance it, they will have to take out a much higher mortgage rate.

There is really only one way to avoid this situation is to sell and rent out the house, or sell and buy the house with cash.

Any other scenario basically doubles the borrower’s interest rate, from that 2-3% range to 6%+.

Not only is this a tough pill to swallow, but it also presents affordability challenges. Especially since home prices have never been that low.

Remember, there is no negative correlation between home prices and mortgage rates. Both may rise together, or fall together.

However, given the sharp increase in mortgage rates recently, there was clearly some downward pressure on home prices, especially in areas of the country that saw huge gains.

However, due to this rate lock-in, the current domestic supply is very limited and this has kept domestic prices high.

Mortgage rates doubled after refi boom

That said, a few years ago the 30 year fixed was priced in the 2-3% range. According to Freddie Mac, it officially hit its lowest level during the week ending January 7, 2021.

At that point, you could get a 30-year fixed mortgage for 2.65%, and could actually get even lower if you paid discount points. Or simply shop around for the best deal.

And that’s exactly what many homeowners did. where did it go “The Great Pandemic Mortgage Refinance Boomresulted in approximately 14 million new mortgages between the second quarter of 2020 and the fourth quarter of 2021.

According to the Federal Reserve Bank of New York, nearly five million borrowers pulled out a total of $430 billion in home equity through their refinances. These are known as cash out refinances.

Another nine million refinanced their loans without equity withdrawals and reduced their monthly payments in the process. This is known as rate and term refinancing.

This resulted in an astonishing $24 billion reduction in the total annual cost of housing. And remember, this could be for the next three decades on these 30-year fixed mortgages.

And of course, fixed, meaning the interest rate doesn’t change no matter what happens to the mortgage in the meantime.

Talking about, the rate running on 30 years fixed rate is now close to 6.5% Freddie Mac,

Can Existing Homeowners Afford to Relocate?

Now taking a mortgage at 2-3% down for more than 6% is clearly counterproductive, especially if the home price doesn’t change much.

This makes a sideways move unprofitable, and a move-up buy unlikely.

Moving from one house to another is not cost-effective. Let us consider an example.

Let’s say you buy a home in 2021 for $500,000, have a 20% down payment, and a 2.75% mortgage for 30 years.

This puts the monthly principal and interest payment at $1,632.96. Great deal!

Now imagine that you are tired of your home, or just want to move for whatever reason. Your favorite home is selling for $475,000. Prices came down a bit.

You put 20% down and end up with a loan amount of $380,000, but the mortgage rate is now 6.5%. Ouch!

This puts the monthly principal and interest payment at $2,401.86. what a drag!

Your mortgage payment went up by about $770, or 47%. Yes, you are reading right. So not only is it a huge deterrent to relocating, it’s also potentially ineffective for some (or many).

This explains why many of today’s homeowners essentially has been closed for their existing properties.

Either because it doesn’t make any financial sense to move, or because it’s not affordable to do so.

In fact, some homeowners may not even be able to get approved for home loans at today’s high rates.

But can’t the mortgage rate lock-in effect go away when rates go down?

Those who don’t buy into this whole mortgage rate lock-in effect argue that life happens. People will move regardless of their low mortgage rates for a variety of reasons.

While this is true, it is not clear how many will move for these reasons. It may be a very small percentage of the overall pie.

They also claim that over time, the value of low rate mortgages is decreasing. After all, every time you make a monthly mortgage payment, you have one less at your disposal.

But remember that the 30-year fix comes with 360 monthly payments. So it will take a very long time for that scenario to unfold.

What can eliminate the mortgage rate lock-in effect is lower mortgage rates. They don’t have to be 2-3% again, just something in the ballpark.

So maybe the 30 year fixed rates will be back in the 4% range. A homeowner would be more comfortable swapping the 3% rate for the 4.5% rate. More affordable too!

You could argue that falling house prices will entice people to move, but they’ll also have to sell in the process. And it’s not clear whether they want to take a haircut and lower their low rates.

Maybe more likely that if this happens they are renting out their home and buying another.

This explains why homeowners can hold onto their mortgages for very long periods of time. And why closure can actually be a wonderful thing.