Why Nobody Wants to Give up a sub-3% Mortgage

Case Shiller Housing Data

Case Shiller numbers are out today, and the data continue to show that transaction volume is down dramatically from its peak of several years ago. See that TTM transaction volume is down by 42% from its peak in August 2021. This is approaching the 47% drop in TTM transaction volume seen during the GFC. The fall in transaction volume during the GFC was associated with a 31% drop in home values over 26 months. Conversely, home prices continue to hit new peaks today.

In Place Mortgages

One of the culprits of this drop in transaction volume is that homeowners do not want to give up their existing mortgages, whose rates are much lower than current mortgage rates. Black Knight’s October 2023 Mortgage Monitor report contains this chart which shows active mortgages by both interest rates and vintage. What the chart details is that well over half of mortgages have rates lower than 4% with a substantial portion under 3%.

Current Mortgage Rates

In contrast, Mortgage News Daily shows the 30-year fixed rate at 7.32% today, significantly higher than almost all existing mortgages.

Home Prices, Mortgage Rates, and Transaction Volume

This chart illustrates the path of mortgage rates both during the GFC fall off in transaction volume and the fall off in transaction volume today. See that during the GFC, mortgage rates stayed in a tight range around 6% whereas the current fall off in transaction volume saw mortgage rates increase from 3% to the mid to high 7% range.

Measuring the Value of Below Market Mortgages

I thought it would be interesting to quantify how much value is associated with these below current mortgage rates. To do this, I built this table which shows the existing mortgage rate on the vertical axis and the new mortgage rate on the horizontal axis. I then calculated what the 30-year monthly mortgage payment would be for $100,000 in principle at the existing mortgage rate then I discounted this payment at the new mortgage rate. The intuition is that the results reflect the value of the below market rate mortgage to the borrower. For instance, a mortgage borrower who has a 2.5% mortgage would be giving up $42,366 in value per $100,000 in principal if they moved and had to get a 7.30% mortgage rate. If the person had a $500,000 mortgage, the forfeiture of the 2.5% mortgage rate would imply giving away an asset that has a $211,830 value. Therefore, it is no wonder few people with low mortgages are selling their properties, they are making wealth maximizing decisions.

The table covers a large range of existing and new mortgages to help convey the fact that there is tremendous value in low-rate mortgages to borrowers, even if they did not lock in rates at rock bottom mortgages. For instance, one with a 4% mortgage rate still has $30,362 in value per $100,000 in principal if current mortgage rates are 7.30%.

It should be noted that this analysis is slightly simplified as many of the very low existing mortgages were originated between 2020 and 2022 so these mortgages do not have 30 years remaining, but instead several years less so these numbers slightly overstate the value associated with low-rate mortgages. Yet they give a very good estimate of the value of these existing mortgages.

Existing Home Inventory

This math helps explain why there are so few active listings, homeowners do not want to relinquish the significant value they have in their below market rate mortgage rates. This chart from Black Knight’s October 2023 Mortgage Monitor report shows that the active listing count of single-family residences and condos is around 750,000 which is around half the inventory between 2012 and 2015 and 60% of the inventory between 2016 and 2019.

Black Knight’s October 2023 Mortgage Monitor report also includes this chart which shows inventory as a percentage of the 2017-2019 inventory for the same month. The chart indicates that national inventory is down around 50% from the 2017-2019 same month average but there is a large dispersion between markets. Hartford, CT is down over 75% but Austin is actually up by 10%.

The Future of Home Prices

In light of this mortgage math, a pertinent question becomes where will the future of home prices be? The Atlanta Fed has their Home Ownership Affordability Index which puts today’s home affordability in historical context. For reference, 100 is considered the affordability threshold such that indices below 100 suggest unaffordability and vice versa. In September the index was 67.1 implying that for home ownership to return to affordability, if there is no change in the other metrics that affect affordability such as median income, interest rates, or other expenses, home prices would need to fall by 49% to return to affordability. While this math may seem extreme to many, the affordability low going into the GFC was 71.5 in July 2006 which would have necessitated at 40% drop in home prices to return to affordability. In actuality, the Case Shiller data showed a 31% drop in home prices over 26 months. This, in combination with a rise in median income and a decrease in mortgage rates returned affordability back to 100 by April 2009.

Conclusion

It will be interesting to see how this plays out with a significant lack of supply due to homeowners not willing to list their properties and relinquish their well below current mortgage rates and the extreme home unaffordability we are currently experiencing. If I had to venture a guess, mine is that home affordability will work its way back to an affordability of 100 and this will be a slow process as inventory will remain low along with transaction volume. The Atlanta Fed's Wage Growth Tracker shows wages still increasing at around 5% a year so if home prices do not nominally grow, affordability will increase. Mortgage rates are also a big unknown but a drop in rates will also help affordability. Yet it is also a possibility that inflation will remain stubbornly high and interest rates and mortgage rates will have to continue to rise. I hypothesize that an important factor keeping home prices at their peak is the significant wealth embedded in the stock market. If the stock market falls significantly in value, this will likely put downward pressure on home prices as it is common for people to use their stock market wealth to purchase homes. There is no shortage of uncertainty in what this future path of affordability looks with the big question being will affordability increase over time slowly or quickly. Time will tell.