The mortgage rate trap is making the housing market worse

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

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

Now that mortgage rates are approaching 5%, these same homeowners are thinking twice when it comes to switching, adding to the inventory shortage that is creating a affordability crisis for buyers.

“Existing homeowners have a disincentive to sell because every dollar borrowed costs more,” Mark Fleming, chief economist at First American Financial Corporation, told Yahoo Money. “The economically rational decision is not to sell.”

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

A year ago, that rate was 3.13%. It reached a record low of 2.65% in January of last year. During that time, millions of homeowners took advantage of the opportunity to get a historically low rate.

Now only 14% of homeowners with a mortgage have a rate of 4.75% or higher, where Freddie’s Mac’s measure is roughly now. They are also the only group of homeowners who could sell their home now and buy another at a rate similar to their current one, if all transactions go through before rates go up again, a dubious feat given that rates have risen in the fastest clip in three months since May 1994, according to Freddie Mac.

Otherwise, the remaining 86% of homeowners are settling in with a mortgage rate of 4.625% or less.

“There is a greater disincentive to move and replace your current mortgagee who is likely to have a lower fixed rate, thus reducing home turnover,” according to a BofA Global Research Note.

86% of homeowners are comfortable with a mortgage rate of 4.625% or lower.  (Credit: Black Knight)

86% of homeowners are comfortable with a mortgage rate of 4.625% or lower. (Credit: Black Knight)

How big is the disincentive?

Take for example a homeowner with a $100,000 mortgage at 3%. That homeowner pays $3,000 a year in interest payments on a 30-year fixed-rate mortgage, Fleming said. If that same homeowner sells their current home and buys another home for $100,000 at 4%, the homeowner would pay $4,500 a year, that’s $1,500 more, or $125 more per month.

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

And that’s what happens: potential sellers do not sell.

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

The result?

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

A house for sale in Washington DC, United States, on December 12, 2021. Annual US house price growth remained strong at 18 percent in October, the highest on record in 45 years index history, according to CoreLogic&# 39;  s house price index.  (Photo by Ting Shen/Xinhua via Getty Images)

A house for sale in Washington DC, United States, on December 12, 2021. Annual US house price growth remained strong at 18 percent in October, the highest on record in 45 years of index history, according to CoreLogic’s Home Price Index. (Photo by Ting Shen/Xinhua via Getty Images)

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

“While the reacceleration of home price gains may be concerning and likely discouraging for first-time and younger buyers, it’s not surprising considering the dire inventory of homes for sale, which continues to decline and continually record new lows. Selma Hepp, deputy chief economist at CoreLogic, in a statement.

While a seller would get a good price for their home, buying another means facing rising mortgage rates, higher prices at the exchange, and an ultra-competitive market due to low inventory—a vicious cycle that continues to deter homeowners from selling.

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

There’s another factor at play, too: inflation, especially as housing costs — both rental and sales prices — soar.

Housing (mortgage or rent) accounts for a third of most family budgets. Even with maintenance costs and increases in homeowners insurance premiums, home ownership is still cheaper, accounting for only a quarter of housing-related expenses, according to Fleming. The rest is a fixed mortgage payment.

“Rent is rising faster than inflation in certain areas,” Fleming said. “The best hedge against inflation is home ownership because the cost of housing remains the same.”

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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 @scribronda

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