What Is The ‘Lock-In Effect’ And How Big Is It?

Before we get to some pretty crazy news — data actually — on housing, a quick thought on the current state of the market. Particularly tech and AI. 

You can’t jump to conclusions in either direction after a day or two of action. This is part of what makes investing potentially difficult and so, so easy at the same time. 

On one hand, when there’s downside or a correction, deciding whether or not to buy more can be scary. You ask yourself things like, what if it drops further or what if it never recovers? When things fly higher and higher, you might wonder, is this finally the top? 

It, in this case, being any one or all of the names in today’s Trackstar top five and beyond. Indeed, 8 of the 10 most searched names across the universe of stocks are tech stocks. No surprise. They have been market leaders for a long time. And, while we always urge caution, The Juice thinks this will continue to be the case, over the long haul, but not without some hiccups along the way. 

So, on the other hand, a slow and steady wins the race approach of regularly buying broad market and other low-cost index ETFs and your favorite individual stocks likely makes sense, particularly if you have a time horizon measured in decades. As we noted yesterday, don’t get too fancy. You can invest in artificial intelligence, for example, without getting into fancy ETFs that do very little that’s different other than charge high expense ratios. 

Anyhow, that’s our two cents on that. More on AI investing in tomorrow’s Juice.

Today, housing. And damn. The Federal Housing Finance Agency (FHFA) put out some interesting numbers the other day, focused on the lock-in effect. That is, the dynamic where a homebuyer “locked in” a relatively low mortgage interest rate and, now, with rates much higher, they refuse to sell. 

Last week, the interest rate on a 30-year mortgage hit 7.5%. It was at 8.0% in October, 2023. And there’s no signs of them coming down now that the Fed likely won’t execute rate cuts anytime soon with inflation humming along. 

During the pandemic, rates persisted at and below 3.0% for a long time. So, they have more than doubled. 

Here are some tidbits, interspersed with The Juice’s three cents, directly from a recent FHFA report:

• “In the United States, nearly all 50 million active mortgages have fixed rates, and most have interest rates far below prevailing market rates, creating a disincentive to sell.”

This is good and bad. Good because these people with low rates obviously bought at the right time. Bad because lots of things do not happen in the economy because of the lock-in effect. Not only does real estate activity slow, helping contribute to stubbornly high (and higher) prices, but people don’t, for example, move to take new jobs. 

• The FHFA “paper finds that for every percentage point that market mortgage rates exceed the origination interest rate, the probability of sale is decreased by 18.1%.”
• “This mortgage rate lock-in led to a 57% reduction in home sales with fixed-rate mortgages in 2023Q4 and prevented 1.33 million sales between 2022Q2 and 2023Q4.”
• “The supply reduction increased home prices by 5.7%, outweighing the direct impact of elevated rates, which decreased prices by 3.3%.”

Wow. And we’re not surprised. 

On the flipside, as rates come down (assuming they eventually do), The Juice thinks the number of buyers who feel the urge to get while the getting is good will outnumber sellers, leading to bidding wars with so many people flush with cash and spending it to make compelling offers.

It’s really incredible to look at the markets where the lock-in effect is most pronounced. Where the difference between the low interest rates homeowners secured and what they’d get now is the greatest:

• San Jose-Sunnyvale-Santa Clara, CA: 3.68%
• San Francisco-Oakland-Fremont, CA: 3.61%
• Oxnard-Thousand Oaks-Ventura, CA: 3.59%
• San Diego-Chula Vista-Carlsbad, CA: 3.59%
• San Luis Obispo-Paso Robles, CA: 3.56%
• Boulder, CO : 3.55%
• Santa Rosa-Petaluma, CA: 3.54%
• Santa Cruz-Watsonville, CA: 3.54%
• Sacramento-Roseville-Folsom, CA: 3.51%
• Santa Maria-Santa Barbara, CA: 3.51% 

In the United States, the average differential is 3.24%. 

As is often the case on housing, California dominates the list. 

You can check out the entire, very detailed FHFA report here. 

The Bottom Line: It’s one of the biggest questions facing people sitting on the sidelines right now. While we’re not fans at all of the Marry The House, Date The Rate advice realtors like to give, we understand the conundrum. 

Sometimes we don’t like reality, but we have to live with it. It might just be the case that home ownership is out of the question for large numbers of American renters right now. While this might sting, it will sting even more to get into an unaffordable situation and regret throwing your monthly budget out of whack. 

The big question to ask is, will home ownership make me better off financially today and for the foreseeable future than I was yesterday? 

We would love to hear your answer to this question at the feedback link below.

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