A battle breaks out in the US housing market as declining affordability collides with the ‘lock-in effect’

Among outstanding mortgages, 91% have an interest rate below 5.00%. Getty Images

In a clash of conflicting forces, the US housing market finds itself embroiled in a fierce battle. On the one hand, housing prices are being pushed down by reduced affordability as a result of an increase in mortgage rates from 3% to over 6% in 2022, just after national housing prices rose by more than 40% during the pandemic housing boom. On the other hand, the lack of existing inventory, exacerbated by the so-called “lock-in effect”, as many homeowners are reluctant to sell and buy new, fearing the trade-off from 2% or 3% mortgage rates to one in the range of 6 % to 7%, pushing housing prices upwards.

Housing economists say neither force should be ignored.

The rise in mortgage rates in 2022 caught many potential buyers off guard, reducing their purchasing power and making home ownership less affordable. With mortgage rates doubling in such a short period of time, housing affordability (or rather the lack of affordability) as tracked by the Federal Reserve Bank of Atlanta has reached levels not seen since the peak of the bubble in 2006. This affordability crisis translated into a home price correction last autumn, which delivered its biggest blow in overheated markets in the south west and west coast. The affordability crisis continues to sideline many potential buyers, hindering demand and leading to a slowdown in home sales.

At the same time, the housing market is strained by a lack of available inventory. The lock-in effect, a term used to describe homeowners’ reluctance to sell their properties due to fear of higher mortgage rates, has resulted in a shortage of existing homes on the market. Homeowners, who benefit from historically low interest rates, are reluctant to give up their favorable financing terms, creating a bottleneck in housing supply. According to Realtor.com, there were 26.2% fewer homes listed for sale in June 2023 than in June 2022, and 28.9% fewer than in June 2019. This limited inventory has driven competition among buyers, causing home prices to rise in the first time. half of the year – the seasonally strong part of the year – in most markets.

To better understand the “lock-in” effect, consider the fact that 91% of mortgage borrowers have an interest rate below 5%, including 70.7% with an interest rate below 4%. For these homeowners, selling and buying a property right now at a mortgage rate of 6% or 7% just doesn’t make a lot of sense.

It’s not just potential buyers and sellers who feel the strain; the consequences extend to real estate agents who depend on transaction volume to make a living. With the rapid deterioration of housing affordability and the shortage of affordable housing, real estate agents and brokers are struggling with limited opportunities to facilitate sales and earn commissions. The declining transaction volumes have dealt a blow to their financial stability and put the viability of some businesses at risk.

So who will win? Will strained affordability push national housing prices lower, or will a lack of existing inventory lead to higher national prices?

According to firms such as Zillow and CoreLogic, national home prices have already bottomed and are projected to continue rising over the next 12 months. The scarcity of existing inventory, they say, means buyers have no choice but to drive prices higher.

Moody’s Analytics Chief Economist Mark Zandi has a different view. He expects home prices to improve over the next few years as mortgage rates slowly move from around 6.5% in 2023 to 5.5% in 2025, and as national home prices eventually fall around 8% from top to bottom. In other words, Zandi expects strained affordability to overcome the lack of inventory.

“In our thinking this [price] weakness plays out over the next three years, there’s no cliff event here, it’s more of a slow grind lower, says Zandi Fortune.

If by chance Zandi’s team gets it wrong and “prices end up being stronger than expected,” he claims it will be because of the prevailing lock-in effect, as individuals choose to downsize and inventory shortages continue to increase. national housing prices are rising.

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