The era of lower-than-ever mortgage rates is long gone, and it’s been replaced with rates hovering around 7%. But homeowners who locked in lower rates before or during the Pandemic Housing Boom aren’t selling. In fact, some of them are becoming “accidental landlords,” simply because they don’t want to lose their low rates of the past.
That being said, the so-called lock-in effect is putting pressure on both sides of the market. There aren’t as many buyers looking for new digs and not as many sellers looking to move up or downsize, if they’ll get stuck with a mortgage rate more than twice as high as their old one.
Redfin’s chief economist Daryl Fairweather told Fortune that high rates are constricting activity. “They’re looking at their monthly payment, which is quite low if they locked in a 3% mortgage rate compared to what their monthly payment would be if they sold and bought again, which would be quite high given how high mortgage rates are,” Fairweather said. “And it just makes a lot of sense for them to hold on to that low interest rate.”
Although rates are down from their 7.37% peak, the 30-year fixed mortgage rate came in at 6.57% on Monday. According to Goldman Sachs, 99% of borrowers have a mortgage rate lower than 6% (or the current market rate). Of those, 28% locked in rates at or below 3% and 72% locked in rates at or below 4%.
So if you took on a $700,000 mortgage with a 7% rate, your total monthly payment would be $4,657. But with the same size loan at a 4% rate, your monthly payment would be $3,342. Let’s say it’s a 3% rate with the same size loan, your monthly payment would be $2,951. It’s the golden-handcuffs of mortgage rates, and it’s keeping homeowners with low rates from selling and turning some into landlords.
Fairweather said there’s both anecdotal evidence and data showing that homeowners are holding on tight to their low rates. For example, new listings of homes for sale fell 21.7% year-over-year for the four-week period ending March 5, making it the biggest decline in two months, according to Redfin. In the same period, the biggest declines were seen in Sacramento (at -45.6%), Oakland (-44.5%), Portland (-42.3%), San Jose (-42.1%), and Seattle (-41.2%).
Michael Zuber, author of One Rental at a Time and former tech worker turned real estate investor, told Fortune that a 30-year fixed mortgage at a rate of 3% is without question one of the best assets most homeowners will ever have.
“They shouldn’t sell, they should rent it out,” Zuber said, adding that several people on Twitter have told him they’re making around $1,000 a month after expenses from doing exactly that, sarcastically adding that the prospect of that “doesn’t suck.”
As for those who may not want to deal with the hassle that’s sometimes associated with renting out their property or even just being a landlord, Zuber said “if you don't like money, go ahead [and sell].” With his own properties, Zuber said he spent nine months refinancing all his debt to sub-4% around the end of 2020 and beginning of 2021, all fixed for 30 years.
“Inflation is real, but when you have an asset where the debt is fixed, and especially if it’s fixed at 3% and we’re running at inflation of above 3%, you win. It’s like printing money,” Zuber said. “It’s the 30-year fixed rate debt, that’s the magic in this.”
The CEO and founder of wealth and investment website Top Dollar, Josh Dudick, told Fortune that once mortgage rates dropped, around 2020 and 2021, he refinanced his vacation home in the Hamptons at a 30-year fixed rate below 3%. Dudick said he was thinking of selling but decided to rent it out instead because he’d have to pay capital gains on his return and he’d lose that “really low mortgage rate” he locked in. With renting it out, Dudick’s covering his monthly mortgage payments and some, all the while the value of the home (that he originally purchased for more than $1.5 million) has doubled, Dudick said.
“You can no longer lock in that incredible leverage, so at this point, I plan to just hold steady… I still have a really good levered return” Dudick told Fortune, adding that even if rates go down a bit, he’s not planning to sell.
David Highbarger, an agile coach and founder of Reaction Agility, told Fortune that he was thinking of selling his home in Florida but “hated the idea of wasting” his low 3% rate, especially because he was looking at a rate of around 6.5% for his next home. Highbarger bought the home a little over a year ago, but needed to move for personal reasons.
“When I started looking at buying another home I was blown away by the 6.5%…even with [a high credit] score, they still want 6.5%, which kills me,” Highbarger said.
After talking with his neighbors and learning how much they were asking tenants to pay for rent, Highbarger decided to rent it out, which now covers his monthly mortgage payment, insurance, and taxes—making him a small profit each month. Highbarger said it “seems like a better return, a better use of my money, than just owning it,” particularly, as the home appreciates. Highbarger added later that the 3% rate is really what’s enabling him to do this, and he hasn’t had much trouble so far considering there’s “no shortage of people looking for rentals.”
Los Angeles-based real estate agent with Compass, Mackenzie Stone, told Fortune that everyone around her was buying, including her clients, and she had to get in on all the action. Stone bought her home in Los Angeles in the summer of 2021 when rates were lower but expected to climb up. Her offer was one of 30, all over the asking price. She locked in a 30-year fixed rate in the low fours, which Stone says, “is absolutely crazy compared to where they are today.”
Stone purchased the home for more than $1.6 million and expects to eventually sell as its value increases, but she’s “really holding on at this point just because of the low interest rate.” Instead of renting it out long-term, Stone is renting it out through Airbnb and making about three times her monthly mortgage because of the low rate.
With fewer sellers, inventory is tightened and there’s less supply. Zuber told Fortune that in “one market there’s actually three markets,” the luxury market, the move-up market, and the first-time homebuyer market. The luxury market is down, with purchases falling a record 44.6% year-over-year during the three months ending Jan. 31., according to Redfin. The move-up market is “dead, for the most part, because in order to move up you have to sell the first home,” Zuber said. But the first-time homebuyer market is hot because there’s not enough inventory, which is exacerbated by homeowners that have locked in their low rates and are choosing not to sell.
This story was originally featured on Fortune.com
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Now, let's delve into the concepts highlighted in the provided article:
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Mortgage Rates and Lock-In Effect: The article discusses the shift from historically low mortgage rates to rates around 7%. Homeowners who secured lower rates during or before the Pandemic Housing Boom are reluctant to sell, leading to a phenomenon called the "lock-in effect." This effect results in fewer buyers seeking new homes and fewer sellers looking to move due to the fear of higher mortgage rates.
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Impact on Housing Market Activity: Redfin's chief economist, Daryl Fairweather, notes that high mortgage rates are constraining housing market activity. Homeowners, especially those with lower rates, are inclined to hold onto their properties to maintain lower monthly payments, impacting new listings. The decline in new listings is evident in various regions, with significant drops in places like Sacramento, Oakland, Portland, San Jose, and Seattle.
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Financial Incentives for Homeowners: The article highlights that homeowners with mortgage rates below 6%, and especially those below 4%, are in the majority. The financial incentive for holding onto these low rates is emphasized by comparing monthly payments for a $700,000 mortgage at different interest rates. This concept of "golden-handcuffs" explains why homeowners are choosing to become landlords instead of selling.
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Renting Out Instead of Selling: Real estate investor Michael Zuber advocates for homeowners with low mortgage rates to consider renting out their properties rather than selling. He emphasizes the benefits of fixed-rate debt, particularly at lower interest rates, stating that it's akin to "printing money." Anecdotal evidence from Twitter users supports the idea that renting can provide a profitable alternative.
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Market Segmentation and Impact on Inventory: The article mentions three distinct markets: luxury, move-up, and first-time homebuyer markets. The luxury market has seen a significant decline, while the move-up market is impacted because homeowners are hesitant to sell their first homes. The first-time homebuyer market is described as hot due to a lack of inventory, exacerbated by homeowners holding onto their low-rate mortgages.
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Individual Homeowner Perspectives: Personal stories from homeowners like Josh Dudick, David Highbarger, and Mackenzie Stone provide real-world examples of the decision-making process. These individuals share their experiences of refinancing at low rates, considering renting instead of selling, and leveraging the current market conditions to their advantage.
In summary, the article paints a comprehensive picture of the current housing market dynamics, with a focus on the impact of rising mortgage rates, the lock-in effect, and how individual homeowners are navigating these challenges.
