Harvard JCHS: Did Mortgages With Locked-in Low Rates Lead to Rising House Prices?

Did rising interest rates reduce the supply of homes because owners with low interest rate mortgages opted to keep their homes rather than selling? A new report from the Harvard University Joint Center for Housing Studies says yes.

Justin Katz, Ph.D. candidate at Harvard University, and Harvard Business School’s Robert Minton released a working paper last week examining what they call “rate lock.”

“We start by observing that rate lock does not obviously impact house prices,” Katz noted in a blog post about the research. “By reducing the number of home sellers, it also reduces the number of buyers because there are fewer current owners shopping for new homes. If potential sellers would have bought another home in the same housing market, then supply and demand fall equally, and prices remain unchanged. However, if sellers would have bought in a different market, rate lock affects relative demand, and hence relative price. Aggregating across all homeowners, if rate lock reduces moves by owners who would have otherwise exited to the rental market, the overall supply of owner-occupied homes declines, increasing house prices relative to rents.”

Katz and Minton used Federal Reserve data to quantify the impact of rate lock on house prices, home sales and residential investment. “We first show that the rate lock incentive increases local price growth by reducing exit from the local housing market.”

“Our analyses imply that rate lock significantly increases prices: a 1 percentage-point decrease in the average outstanding mortgage rate in 2021 increased nominal house price growth by 8 percentage points between 2021 and 2023,” Katz wrote. “Moreover, rate lock affects prices much more in markets where the supply of new housing is constrained.”

The report also examined how much rate lock can offset the negative price effects of reduced housing demand when interest rates rise. “We show that rate lock increases aggregate house prices, relative to rents, by reducing moves from owning to renting,” Katz wrote. “Rate lock explains 40% of the gap between the predicted decrease in prices and the observed price growth between 2021 and 2023.”

“Our research has two policy implications,” the report said. “First, for central bankers and regulators monitoring house prices for signs of credit market exuberance, our findings show that rate lock can help explain elevated house prices relative to traditional indicators like rents and interest rates. The price impacts of rate lock also imply that interest rates have a path-dependent impact on house prices: after a long period of low rates, most outstanding mortgages have low rates, and prices fall by less when rates subsequently rise.”

The report noted that home-sale decisions of existing owners only affect house prices in areas where supply is constrained. “This emphasizes that policies to improve housing affordability should focus on expanding housing supply,” it said. “By contrast, policy interventions that affect home sales choices by changing mortgage structure, such as portability, would have little impact on aggregate house prices.”

Study co-author Justin Katz participated in a webinar on March 6 to discuss his research.