Mortgage rates are dropping, but the housing market is still stuck. Here's why.

By Aarthi Swaminathan

'The lock-in effect is substantial,' says Mark Palim, Fannie Mae's chief economist

A crisis of unaffordability has held the housing market hostage. That situation is not likely to change anytime soon, one prominent economist says - and there's one culprit.

A sharp drop in mortgage rates in recent weeks prompted a flurry of refinance activity, while home listings are rising. Yet home-buying demand has yet to pick up. That's because of the lock-in effect, or the suppressed number of home listings resulting from homeowners reluctant to part with their ultralow mortgage rates, according to Mark Palim, the chief economist at Fannie Mae.

"The lock-in effect is substantial," Palim told MarketWatch.

Fannie Mae, along with Freddie Mac, backs a significant portion of all residential mortgages in the U.S.

When the Federal Reserve cut interest rates during the COVID-19 pandemic to spur economic growth, the 30-year mortgage rate sank below 3%, crossing that threshold in mid-2020 for the first time since Freddie Mac began keeping track of the data. Low rates sparked a home-buying frenzy as renters, homeowners and investors clamored to lock in a once-in-a-lifetime rate.

That has resulted in the vast majority of outstanding mortgages carrying an interest rate below the current average of 6%. In fact, one in five homeowners with a mortgage has a rate of under 3%, according to an analysis by Realtor.com.

Realtor.com is operated by News Corp subsidiary Move Inc. MarketWatch publisher Dow Jones is also a subsidiary of News Corp.

Even if they've outgrown their current home, live in a school district they don't like, or have a house that's too big or small for their needs, many homeowners across the U.S. have stayed put due to their low mortgage rate. In fact, some wouldn't even be able to afford to buy their own house at today's mortgage rates.

For these homeowners to move, they would need a compelling reason, Palim said - one that has yet to emerge.

Most people time a home sale to a major life event. In a recent survey by the real-estate company Zillow, about eight in 10 sellers cited a life event as a key reason they decided to move and sell their home.

The most common event cited was a change in household or family size, such as having a baby or becoming empty nesters. The next most common event was a new job or job transfer.

But for homeowners who aren't going through major life changes and have an ultralow rate, there's little incentive to move.

That, in turn, keeps a lid on not only how many homes are listed but also home-buying activity, Palim said. So "it's going to take a while for people to be interested in listing their home," he added.

Nonfinancial factors are another reason the lock-in effect has persisted and will continue to linger for a while. Many people really like their current home and neighborhood, or enjoy having their family or job close by, giving them little reason to move, Palim added, citing previous research by Fannie Mae.

The bottom line is that there is no "magic" mortgage rate that will spur home-buying activity, Palim said. Even as rates fall, which helps home buyers, there is no critical threshold at which a significant surge in home listings and sales will be triggered.

If rates fall further, home buyers will find it more affordable to buy a home. "But if they decline too fast, that could reignite home-price appreciation," he added.

-Aarthi Swaminathan

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10-03-24 1200ET

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