Federal Reserve Bank of Philadelphia Examines Mortgage Lock-In Effect

Can elevated mortgage rates help explain recent real estate market tightness? New research from the Federal Reserve Bank of Philadelphia suggests yes.

The paper, Is Mortgage Lock-In Responsible for Housing Market Tightness? was written by FRB of Philadelphia Senior Economist Kyle Mangum and Aaron Graybill, formerly a research associate with the FRB of Philadelphia, currently a Ph.D. student at the Stanford University Graduate School of Business. It examined whether elevated interest rates explain recent real estate market tightness.

Mangum and Graybill find that elevated mortgage rates discourage homeowners from moving because relocating triggers a reset of mortgage terms, a phenomenon termed “lock-in.”

The authors used transaction-level data to estimate the probability of sale as a function of tenure and market conditions, including mortgage rate gaps. “These estimates quantify missing sellers who have not entered the market due to elevated rates,” the authors said.

“We then calibrate a search and matching model measuring mortgage rate effects on buyers alongside seller lock-in effects,” the authors continued. “Results indicate lock-in causes sellers to withdraw, reducing transactions. However, buyers are more sensitive to mortgage rates than sellers are to lock-in, meaning a rate drop would increase sales volumes but not reduce market tightness.”

“We find, like much of the rest of the literature, that sellers are less likely to offer their homes for sale when prevailing mortgage rates exceed their current contract rates,” the authors concluded. “We add to this line of research a model that accounts for various owner tenure types and the non-monotonic hazard rate of sales with respect to tenure length. Notably, recent years have fewer homes in the high-turnover part of their tenure profile, which may be further reducing inflows to the for-sale market.”

The report uses a search and matching model to infer the number of buyers present in the market at a given time. “We find such buyers are highly sensitive to mortgage rates. Consequently, though a reduction in mortgage rates would increase seller inflows, it would also induce a demand response of buyer inflows,” the authors wrote.

“At the elasticities we estimate, the buyer effect would dominate, indicating that lower mortgage rates would not reduce market tightness. Sales volumes, however, would increase by the amplification of both buyers and sellers flowing in, creating a thicker market for sales to take place,” they concluded.

Eric Bernstein, president and co-founder of LendFriend Mortgage, Austin, Texas, noted the lock-in effect is real but said it does not affect all borrowers equally. “Where we see it break down most often is with self-employed clients, real estate investors, and others whose financial profiles don’t fit a conventional rate-and-term refinance mold — for them, Non-QM structures like bank statement loans or asset depletion products can reopen doors that a rate gap alone would otherwise keep shut.”