What this article covers
Opher Ganel explains why today’s homebuyers face a double squeeze: mortgage rates roughly double their 2021 levels raise monthly payments, and the same rates keep existing owners from selling. Using Redfin, Census and NAR data, he shows how the rate lock-in effect shrinks supply and props up prices, and runs the numbers on why downsizing to grow a retirement nest egg rarely works at current rates.
Key Takeaways
High mortgage rates hurt homebuyers twice: higher payments and fewer homes for sale
With rates roughly double their 2021 levels, the same loan costs far more each month. Opher Ganel estimates that a homeowner moving from a 3% loan to a similarly priced home at 6.48% could see monthly housing costs jump about 36%, or nearly $800.
The mortgage rate lock-in effect is keeping homeowners from selling and propping up prices
A Redfin study found nearly 92% of outstanding mortgages had rates under 6% and 62% were below 4%, so few owners can move without a much costlier loan. Opher estimates only about 3.7 million homes are likely to sell in a year, consistent with Redfin’s finding of roughly 40% fewer homes for sale than before the pandemic, while pent-up demand keeps prices from falling much.
Downsizing to grow your retirement nest egg rarely pays off when mortgage rates are high
In Opher’s example, a homeowner with a $200k loan at 3% who sells a $500k home and buys a $350k one at 6.5% either uses all the equity and saves $444 a month but adds nothing to savings, or invests part of it and ends up paying $502 to $875 more per month than the investments can comfortably cover. He suggests downsizing is unlikely to work well until rates fall to 5%, or preferably 4%.
Something interesting is happening in real estate.
And if you’re looking to buy a home, that “interesting” is in the sense of what people often refer to as an ancient Chinese curse, “May you live in interesting times.”
While the current market’s 6.48% rates aren’t especially high compared to the 7.75% average from 1970 to date, you’d have to go back over 20 years (to 2002) to find higher annual average rates.
That’s exceedingly bad news if you’re hoping to buy a home, for two reasons.
- First, the obvious one – with mortgage rates double what they were in 2021, payments are higher for the same loan amount (even if we ignore the big increase in home prices).
- Second, high rates are pushing supply down, propping up home prices. To see why, read on…
Why High Mortgage Rates Hurt More After Years of Ultra-Low Rates
Ordinarily, if mortgage rates are high but have been high for a while, you only feel the pain of the first of the above-mentioned problems.
However, coming off historically low rates as recent as 17 months ago, almost all existing mortgages are at much lower rates than what’s currently available for purchase or refinancing, many at rates that are half the currently available rates.
According to a recent Redfin study:
- Nearly 92% of outstanding residential mortgages have rates under 6%
- Over 82% are under 5% interest
- 62% are below 4%
- Nearly 24% are sub-3%.
This compares to an earlier Redfin study that showed 85% of mortgages below 5% interest. In the past 9 months or so, outstanding mortgages with rates over 5% went up from 15% to 18%.
How Rate Lock-In Shrinks the Supply of Homes for Sale
What can we learn from these numbers?
- Only a small fraction of homeowners with mortgages can find a new mortgage at rates comparable to what they’re paying now.
- If we assume the 3% increase (from 15% to 18% of mortgages) at high rates reflects people who were forced to move in 9 months, the annual rate of such forced situations may be as low as 4% a year.
According to the US Census Bureau, as of 2021, there were about 143.8 million housing units (houses, apartments, etc., whether owned or rented) in the US. With an owner-occupied rate of 64.6%, this implies 92.9 million owner-occupied housing units. Four percent of that implies 3.7 million housing units likely to sell over a year.
According to the National Association of Realtors (NAR), in 2020, 5.64 million existing homes and 822,000 newly constructed homes were sold in the US, for a total of about 6.5 million homes.
According to Redfin, there are now about 40% fewer houses available for sale than there were before the pandemic, implying 3.9 million, in good agreement with my above estimate of 3.7 million.
That Redfin article says, “Redfin’s Homebuyer Demand Index–a measure of requests for tours and other services from Redfin agents–is up over the last two weeks and near its highest level in a year. That means there’s a fair amount of pent-up demand, and many buyers will be ready to pounce when more homes hit the market. Demand outpacing supply is preventing home prices from falling drastically: The median sale price is down just 1.1%, the smallest annual decline in three months.”
Why the Mortgage Rate Lock-In Effect Keeps Homeowners From Selling
Assuming the median home price of $436,800 (per the St. Louis Fed) and the 14% median down payment (per Bankrate), we can estimate the typical new mortgage amount is around $375,600.
Here are the estimated monthly payments for such a mortgage at different interest rates. For insurance, we’ll scale from Bankrate’s estimate of $1428/year for a $250,000 home to $2495 for a median-priced home. For property tax, we’ll assume the national average of 1.11% (per the Motley Fool).
- If your current interest rate is 3% and you sell, moving to a similarly priced home, your monthly payments could jump by 36%, or nearly $800!
- Starting from a 4% loan, your increase would be a more moderate but still unacceptably high, at 24% or nearly $600 a month.
- In either case, upgrading to a larger, more expensive home would increase your housing costs even more.
This is why current homeowners are reluctant to sell until rates drop (or they’re forced to move by circumstances).
As Redfin reports, “Just over one-quarter (27%) of U.S. homeowners who are considering listing their home in the next year would feel more urgency to sell if rates dropped to 5% or below. That’s according to a Redfin survey conducted by Qualtrics in early June. Roughly half (49%) would feel more urgency if rates were to drop to 4% or below, and the share increases to 78% if they were to drop to 3% or below—a situation that is highly unlikely any time in the near future.”
Redfin also reports that nearly 60% of homeowners with mortgages bought their homes as recently as four years ago. Given the 13.2-year average period people stay in their homes (as of 2021), those who bought so recently are unlikely to want to move in the near future.
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Why Downsizing to Boost Your Retirement Nest Egg Is Harder at Today’s Rates
If you’re currently paying a mortgage and were planning to downsize as a way of taking advantage of the dramatic home price increases of recent years, you may need to think again.
Say you bought your home for $300k 10 years ago and refinanced to a $200k 3% loan in mid-2021 with a $843 monthly payment (principal and interest). Adding insurance and taxes, at a combined 1.61% of your home’s new $500k value per year), you’re paying about $1514 a month.
Your plan may have been to sell, pay off the mortgage, and use some or all of the remaining proceeds to buy a smaller home. You prefer to invest some of the money, because you’re nearing retirement, and your nest egg is nowhere near big enough for a comfortable retirement.
Here’s the problem…
A Downsizing Example: Three Ways to Use $258k of Home Equity
If you sell, you’ll have about $450k after closing costs, and after paying off your $192k balance, you’ll have $258k. Let’s see what this lets you do if you want to buy a $350k home.
- If you apply the full $258k to the new home’s purchase, you’ll likely need a $95k mortgage (assuming $3k closing costs); at a rate of 6.5%, your monthly payment will be about $1070, saving you $444 a month, but doing nothing to increase your nest egg.
- If you apply half the $258k to the purchase, your loan amount would be about $224k, and at 6.5% your new payment would be $2016, or $502 a month higher than your current mortgage! And the extra $129k you can add to your investments? That will barely cover this extra cost (assuming you draw 5% a year).
- If you only put 20% ($70k) down, your loan balance will be $283k, which at 6.5% means your monthly payment will be a mind-boggling $2389, $875 higher than you’re paying now. The extra $188k you invest will only cover about $783 of that (again, assuming a 5% draw).
Clearly, downsizing to bolster your nest egg will be much harder in today’s environment than it was just a year and a half ago.
The Bottom Line: Should You Buy, Rent or Wait for Lower Mortgage Rates?
Given the tight supply and high mortgage rates, finding a home to buy that you can afford (both in terms of the down payment and the monthly mortgage payment) is hard.
Really hard.
And the problem is that, especially with the Fed’s recent messaging, interest rates aren’t likely to drop significantly for a long time.
This may well be a good time to consider renting instead. The long-term financial implications may favor that in most markets for quite a while.
If you already own a home, you’re almost certainly “handcuffed” by your relatively low existing payments and are probably hoping circumstances don’t force you to sell.
If you were thinking of downsizing to pull money out of your equity to increase your retirement nest egg, that’s unlikely to work well until mortgage rates drop down to 5%, or preferably 4%.
What to Read Next:
Frequently Asked Questions
Why are high mortgage rates a problem for homebuyers?
Higher rates raise the monthly payment on the same loan amount, and they also reduce the number of homes for sale. Because most existing homeowners hold much cheaper mortgages, many are reluctant to sell, which keeps supply tight and props up prices.
What is the mortgage rate lock-in effect?
It describes homeowners who stay put because selling would mean giving up a low-rate mortgage for a much higher one. The article cites a Redfin study showing nearly 92% of outstanding mortgages had rates under 6%, and a Redfin survey in which homeowners said lower rates would make them feel more urgency to sell.
How much more would I pay if I sold and bought a similar home at a higher rate?
Opher Ganel estimates that moving from a 3% mortgage to a similarly priced home at 6.48% could raise monthly payments (including insurance and property tax) by about 36%, or nearly $800. Starting from a 4% loan, the increase would be about 24%, or nearly $600 a month, and buying a larger home would cost even more.
Does downsizing make sense to boost retirement savings when mortgage rates are high?
Often not. In the article’s example, using all your equity on a smaller home lowers your payment but adds nothing to your nest egg, while investing part of the equity leaves you with a higher payment than a 5% withdrawal from those investments can comfortably cover. The author suggests downsizing is unlikely to work well until rates drop to 5%, or preferably 4%.
Should I rent instead of buying a home while mortgage rates are high?
The author suggests this may well be a good time to consider renting, since tight supply and high rates make it hard to find a home you can afford, both for the down payment and the monthly payment. He adds that the long-term financial implications may favor renting in most markets for quite a while.
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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.