The Lock-In Effect of Rising Mortgage Rates with FHFA’s Jonah Coste

Mike Simonson here. Thanks for joining me today. Welcome to the Top of Mind podcast. If you follow along with Altos Research, you're familiar with our weekly real estate market data series of videos that we do with the top of Mind podcast. We seek to add context to the discussion about what's happening in the market from leaders in the industry each week. Of course, Altos research tracks every home for sale in the country, all the pricing, all the supply and demand and all the changes in that data. And we make it available to you before you see it in the traditional channels. People desperately need to know what's happening in the housing market right now. So if you need to communicate about this market to your clients, to buyers and sellers, go to altos research.com and just book a free consult with our team. We can review your local market, we can teach you how to use market data in your business.

(01:09)
Okay, let's get to the show today. My guest today is Jonah Coast. Jonah conducts research on housing and mortgage markets at the Federal Housing Finance Agency FHFA. He's especially interested in topics related to household decision making and housing supply. Two things we talk about a lot on the top of Mind podcast. He also has experience working in consumer finance topics at the Federal Reserve Bank of Philadelphia. So if you're a regular listener to the podcast here, you'll know that I try to learn the best thinking on how to solve America's many housing challenges. A big challenge we're facing now has been called the mortgage rate.

(01:59)
We had such a boom in buying with ultra low mortgage rates and now that mortgage rates are higher, we're seeing the hangover effects. So I asked Jonah to join me today because of the work they've done at FHFA to quantify the mortgage rate lock-in effect and what it means for the future of housing in America. So I'm really excited to tap into his expertise. Jonah and the team at FHFA recently published a paper on the mortgage rate and so we're going to talk about the details of that and then some other things about housing in general and where we're going in the country. Jonah, welcome to the show.

Great to be here.

Great. I'm so glad we made this happen. Let's talk a little bit about the FHA and your background. I'd like to get a little background about who you are and your expertise and what you're working on now before we start getting into the real fun stuff.

Yeah, so let me start off by saying that the views I'm going to say here are mine. They're not the FHFA's and they're not those of my co-authors. But yeah, so the FHFA, it's the regulator for the federal home loan banks and it's the regulator and conservator for Fannie Mae and Freddie Mac. The agency also produces research and data resources aimed at helping researchers, policymakers and the public understand housing and mortgage markets. And so that's the function that I really work in. I'm an economist of the division of Research and Statistics at FHFA and as you mentioned, my primary research interests are household decision-making and housing supply issues.

Great. Well, I want to talk about the paper first of the lock in effect. We're going to spend some good time on that because it said really terrific insights that you published and so we want to learn those, but I'm also interested in some of the bigger, the household decision making, things like that, implications that we might get into. Excuse me. Okay, so let's start with the paper on the effects of the mortgage rate and tell us about the lock-in effect. What is it, how you measure it, how we should think about it. There are different views, people talk about different things about mortgage rate lock-in and implications and I have some opinions on 'em. So tell us your take on what it is and how we should frame our thinking.

Yeah, so as you mentioned, we just released a working paper on this. It's joint work with my colleagues, Ross Baler who's the brains behind the theoretical model in the paper Will Dorner who's a veteran FHFA researcher and our captain, sort of our research team there. And he really understands all the policy in and outs and all the history of all this stuff. And Mike Seiler, who's one of the top academics in real estate who's a visiting scholar at FHFA right now are not at his day job at William and Mary. So what is the locket effect? 96% of active mortgages in the United States are fixed-rate mortgages. So when borrowers have an existing fixed rate that's below the rate that they could get on a new mortgage today, they're less likely to want to sell their home because that would mean giving up this below market rate mortgage and that's what we call the lock-in effect. And we measure it the degree to which any borrower is locked in by the difference between the fixed rate on their mortgage and the rate they could get on a new mortgage. And we call that the rate delta a negative rate delta means borrowers are locked in so they have a lower rate than what they could get today, which is the case for almost all people right now.

Got it. Okay. So you call a negative delta and intuitively it means it makes sense that there's a big change in mortgage payments, then they're less likely to sell their home. And so I think you did some really innovative stuff in the paper about how to determine how likely one would be to sell a home and you did some work with comparing people with fixed rate mortgages to those with variable rate mortgages. So I'm interested in talking exploring that a little bit first, but before we dive into that, tell me about the big conclusions.

Yeah, so I would say there's four primary conclusions to the paper. So the first, as you said, is just about quantifying how walked in everyone is and we find that on average at the most recent data that we have access to, which is the fourth quarter of 2023, the average borrower with fixed rate mortgage was 3.24 percentage points locked in. So they had a mortgage rate that was 3.24% lower than what they could get if they were originating a mortgage in the fourth quarter of 2023. So that's the first point. The second thing is how sensitive are sales to being locked in? And we do a very careful job estimating that and we find that for each percentage point of lock-in it decreases your probability of sale by 18.1%. So that rolls in to right nicely to the third major point, which is what's the aggregate effect? So if you multiply out how locked in everyone is to how sensitive they are, and you do that for each quarter one, we find that the fourth quarter, the peak of walk-in had over 50% decrease in sales of homes with fixed rate mortgages as a result and aggregate over this spell of walk-in which sort of started in the second quarter of 2022, we've lost something like 1.33 million sales due to lockin.

(08:14)
And then finally the fourth point, we want to look at what's the effect on prices. So higher interest rates should have a downward effect on prices because they should decrease demand. And that's sort of been the thinking, that's the conventional thinking of the effect there. But what we show both in our theoretical model and then we sort of confirm the predictions empirically, is that this decrease in supply due to people not wanting to sell has an upward effect on prices. And that upward effect is likely actually a little bit stronger than the direct downward effect through demand. So we find cumulatively since second quarter 2022, something like a 5.7% upward effect due to lock-in which slightly bigger than the 3.3% direct effect from the lower rates.

So that was really cool because that was obviously what we measured directly all year last year. So wow, prices are at the beginning of last year, they were down year over year, but then they started ratcheting higher starting at about the second quarter of last year. Even as sales were falling, we saw prices were, prices were climbing because there was more demand essentially than supply in that. And it was wild because for me and the folks in my position where we're measuring the housing market every day and the expectation was, wow, if demand falls, prices should head down this year and this year being 2023, we should expect that intuitively. But then we started watch observing. I'm like, gosh, that's not happening. So let's start with that fourth one. So the impact on prices. So we observed prices climb because supply was limited.

So there's this sort of weird path dependency that were on the effect of interest rates on prices wherein if you're coming off an era of very low rates, which we certainly were 2020 and 2021, it's the lowest rates ever and people refinance into those low rates. Then the increasing rate, yes it does decrease demand affordability is down as a result and the people can't afford the same house payment or house price that they could before. But even more than that, people don't want to sell and give up their 3% mortgage. And so the affect on supply our data indicates is a little bit stronger than that effect on demand.

It certainly certainly observed that last year. So that makes sense. So then is that related to the absolute levels that we're at? If you go from seven to 10%, do you expect that same reluctance? Does that still kick in or is this a function of the historically best deal that homeowners have ever had? Is it really tied to the low rate or is it tied to the delta?

Yeah, so what we found is that what seems to matter in terms of your likelihood to sale is that difference, what we call the rate delta, the difference between the rate you have and the rate you could get today, if we look only at records from before 2020, so before what we see is a very similar relationship between the delta and your probability of sale. We just don't see these very negative rate deltas that we're seeing now. This high degree of lock-in is somewhat impressive. So we don't see the full relationship that we see today, but it looks very similar when you look even prior to this era of really unprecedented low rates in 20 20, 20 21. Got it.

So it's it is really dramatically illustrated now, but you found that the relationship holds

Yeah, the relationship holds even in the pre covid era.

Right. Okay. So one of the conclusions we talked about here was the 1.3 million fewer sales, fewer sales or fewer sellers. How do you describe that?

Fewer transactions, so fewer sales

Transactions. Okay. And so one of the things I'd like to dive into in a minute is what I describe as a supply constrained market and would there have been more transactions if there was more inventory? There's some things there that we can observe in the altos data. I'd like to dive into that in a minute. First though, exploring the 1.3 million fewer transactions, we could see that if you look at, for example, the headline and AR number was maybe is annualized seasonally adjusted annualized, sometimes they talk about a 6 million rate, sometimes it's maybe five and a half million. And then towards the end of last year, the pace was like under 4 million, so we could see a 30% drop in the total that the seasonally annualized pace there in that number. And we could see it in some of the altos measures as well. For example, we tracking new pendings every week and the homes that went go into contract every week. So we can see the transaction pace right there, the seller 1.3 million and fewer sellers. And this was really over about a 16 or 18 month period, is

That Yeah, so that's seven quarters. So I would be over a 21 month period, 21

Month. So yeah, second quarter of 22 is when rates really did the hockey stick up through the end of 23? Correct. Okay. So we're talking about 1.3 million homes that didn't transact and you had some interesting observations of the paper about utility. Is it a big deal that those people and how should we think about that as a big deal? And I asked this because it kind of goes into the question of policy, what we should do about lock-in effect if it's a big deal that these homes didn't transact, tell me about how to think about utility for these 1.3 million folks.

So in economics, we generally assume people make decisions to maximize their happiness or we call it utility when we see people making different decisions in this case not selling their home than they would if they didn't have this constraint of having to give up their mortgage, we could induce that lockton's keeping them from optimizing their housing choices in one way or another. So this could mean not upsizing a family that's growing that would want to upsize is in a house that's too small for their needs. They're not downsizing, they would like to be spending less of their money on housing, maybe their kids have moved out and so they would like to downsize to a smaller place, but they can't actually save any money by doing that because they would give up a 3% mortgage for a 7% mortgage right now. It could mean not moving for a new job opportunity or for family or other reasons.

(16:37)
It could mean not forming households or making other family decisions. So we actually spoke to two different people who said their divorces were becoming very complicated by the fact that they didn't want to have to give up the mortgage, but it didn't make sense for either party to live in the house alone. And even people who are maybe able to get around this by perhaps instead of selling, renting out their house and buying or renting somewhere else, first off, I think that's a fairly narrow slice of people who could afford or can qualify for a second mortgage and keep their original one. But even if you're able to still do the life choices you would, but through that there's a disutility to being this accidental landlord to having to manage a property that you didn't really want to be. It's just the only way you can hang on to your 3% mortgage.

So when you do things a lot, your life is suboptimized because you've got this, got this thing that it would be dramatically more expensive to change. So that's interesting. And in California, so I'm in California and we talk about it here actually on the podcast a lot. California has prop 13, which keeps our property taxes essentially fixed forever. And one of the things that we can measure in California is how dramatically fewer homes get listed for sale in California compared to other markets. And I think a big component of that is because of prop 13. So we are essentially locked in to ultra low property taxes in California and the number I use, I was just looking at it this morning, so in the San Francisco Bay area there are call it 8 million people and there are 2000 single family homes available on the market for 8 million people in Dallas, six and a half million people. There are 17,000 homes available right now and Dallas, Texas has actually high property taxes and so it actually forces and they're variable much more quickly. So it actually forces people into turning over. And so the Dallas housing market is significantly healthier than any of the California markets and so am I looking at that the same? Is that essentially the same Sonoma?

There are different triggers for lockin in real estate. So like you mentioned, places that have artificial limits on how fast your assessment can grow over time. You get this artificially low tax bill due to having been in your house through a period of rapidly appreciating prices and if you were to move, you give that up and so that could be a source of luck. And there's also not wanting to sell because you don't want to realize capital gains that that applies to more than just housing. That could apply to other financial instruments as well. We also see in periods of time when you have falling prices, you can get lock-in due to not being able to sell because you have negative equity and you won't be able to clear the title with your sale or just a loss aversion wanting to avoid selling at this nominal loss can create a behavioral. So there are many different potential sources of lock-in. Some of them apply regionally, some of 'em apply nationally, definitely one that applies nationally. And is the strongest one right now is this lock-in from fixed rate mortgages

For fixed rate mortgage delta? Yeah. Okay. So do we have a way to quantify, I think we quantify the 1.3 million homes that didn't sell. Do we have economic impact of that lock-in a broader, I think on the other hand, because you talked about in the paper a few things like an aggregate I think benefit of this period of having ultra low rates of $3 trillion I think was the number in there. How should I think about the benefit or the downside, the upside or the downside of this condition, this phase that we've gone through.

So the $3 trillion is sort of like it's this ethereal or conceptual benefit that households with existing mortgages have received by decreasing the present value of the mortgage payments that they're going to have to make. So on average for the average borrower it's worth 60,000. You multiply that by the 50 million mortgages or so that are out there, you get this number of 3 trillion. But unlike paper gains on stock ownership or something, you can't realize it by selling, you can't sell your mortgage in most cases in this country you can't sell your mortgage to someone else. And unlike paper gains, unlike the value of your house, you can't borrow against it. You can't take out a home equity line or another mortgage against the value there. So the only way to get that value is to stay in your current mortgage. And that's what the cause of this lock-in is them wanting to realize this benefit that they've come into by having the low rate mortgage. The aggregate economic effects are probably pretty big, but they're different than this $3 trillion number. This is all the brokers commissions that aren't paid, all the home improvement projects that go along with buying a new house that aren't done. And then yeah, there's a real utility loss, maybe not a loss to GDP or output, but a utility loss to being in a home that's not optimized for you.

That's not optimized. And back to the California thing, unless you happen to have bought a big mansion 40 years ago, everybody in California is suboptimized in other housing, right? We're locked in and that's part of the mix. So that's a fascinating thing On the utility side, the $3 trillion benefits and I think about this and I actually have a question, I dunno if you have a take on this, but as we were going through the last 24 months with inverted yield curve and expectations of recessions coming, that has not materialized. One of my, a hypothesis that I toy with is did that ultra low rate, essentially that $3 trillion benefit if me staying in my house with my payments are a thousand bucks less than they would've been otherwise and now I'm putting that thousand bucks into whatever else and putting it back into the economy. Do you see a world where we avoided the recession, the widely expected recession because the expectations forgot to include this $3 trillion benefit that people were essentially realizing by staying in their home? Does that make sense?

Yeah, I understand the question. I mean I think there's a simple answer and that is a more nuance thing. I think that the simple answer is kind of no because again, people can't spend this $3 trillion, they can't sell anything to realize it and they can't borrow against it. So it's not supporting directly supporting consumer spending. Now the slightly more I think complicated answer there is if you imagine it the counterfactual world where everyone had a adjustable rate mortgage and therefore their payments did go up by on average I think we say the delta is $500 a month or 40% of your principal and interest payment, that would've put a big dent in people's ability to spend. But again, once you're in that counteract show world, you have to think about what else changes. Maybe interest rates would not have needed to rise as much to combat inflation. So it's hard to say that this is what's keeping us from our recession. Okay,

So you mentioned you can't spend it, but in my case I refinanced in whatever November of 2021. I happened to time it pretty well because I had dragged my feet until finally I said I really need to do this and it happened to be just about as low as ago and I was like 2.8 and so I literally went, I put an extra thousand bucks in my pocket every month but before and after that refinance. And so I am literally spending that benefit now and I could move or sell a house and buy another one and have a higher payment and take that back out of my pocket and I'd be on the same path I was two years ago or two and a half years ago. But now literally I had that as cash.

So I think there's an argument I think that I hear you making is that really the monetary stimulus we got in 2020 and 2021 is still having simulative impacts now because you refinanced when rates were low and there's been some recent research I've seen about how there's a path dependency here and future rate cuts won't have the same stimulative benefit because people have these 3% mortgage rates, they're not going to refinance if things go down to five. So you're not going to get unlock consumer spending with rate cuts given that we've gone through this very historically low period. So this path dependency of it, that's not in our paper, but I've seen research talking about that.

Okay, interesting. I'm holding out, maybe we can do some future depth on that topic. Is that a factor that we didn't factor in really that cash flow? I think maybe it was factored in a little bit in some recession forecasters modeling in terms of understanding consumer debt loads and things like that, that got so much better because of that stimulus because rates fell and everybody refinanced and so all the credit card debt went down and all the other kinds of things got improved in that time. So okay, I'm going to interpret that as a maybe perhaps. So we'll take it from there.

(28:18)
Then the next thing that I want to understand, and this is where I think we might have some differences of opinion on what the data says and this is how long we should expect this lockin to last. And in the paper you call it decay, how much does this decay each year? And then can we apply that rate to understanding projecting what we should expect for 20 24, 20 25 in terms of home sales and inventory and things like that? In the paper you described it as a pretty slow decay and that when rates shift higher, that actually prolongs the delta, expands the delta and therefore prolongs the lockin effect. Yeah,

(29:27)
In the altos data what we can see is something a little bit different, which is where we are now two years post interest rate change and we can measure rising interest rates immediately creates more inventory. We can watch the available inventory rise when rates rise and I can, for example, we're tracking, we track new listings every week and this year through the end of the first quarter we have 12% average more listings every week of the first quarter than we did a year ago. So we can start to see that supply climbing both on the new listings volume and the total active inventory. So in the altos data and my view we watch, we can directly track rising rates leads to rising inventory and in my take then is that we will see rising transactions this year because we have more homes on the market, we have more new listings and so we can see that climbing. Now that seems like it would be a contradiction to your conclusions, which is rates are staying higher, the delta stays high, we actually should see and if rates go up from here, we actually see fewer sellers and fewer sales this year.

(31:09)
Let me leave it there. So help me understand how I should be thinking about the data.

Yeah, so let me first try to make sure I'm characterizing your argument correctly. Harris, I guess what I hear you saying is that lock-in may go away when people just get used to higher rates that they need to see the situation as the new normal.

Yes. The way I describe it is we can see consumers are more sensitive to the recent changes in rates than to the absolute levels. So if rates stay at 7%, we can see transaction volume climbing because they're staying around seven, a much shorter window than looking at comparing to the average rate that everybody has.

So a couple things that I think one could help reconcile our views, but then I'll sort of talk about what we're seeing in the data. First off, I think it's not inconsistent with what we find that we're seeing increased transactions in the first quarter. As I say, the lock-in probably peaked in the fourth quarter. That's when rates really peaked, particularly rates for originated loans, which sort of lags the weekly numbers that come out there. So I would expect that if we revisit this with quarter one data or in quarter two data, that we will have seen more transactions and that would be consistent with an easing of the lock-in. Second thing I want to say is it's important to have a little humility about what the data team can and can't tell us. In this case, we're in this fairly unprecedented situation in terms of the level of lock-in. And so it's difficult to draw firm conclusions about what happens if this unprecedented thing lasts 2, 3, 4 years. Having said that, when we look at this, what we find really matters is this difference, this delta between what you could get and what you do get.

(33:24)
Since the working paper has come out, I've done some analysis on does it matter, do we have a lot of pent up demand that's going to overcome the lock in effect, which would be consistent with if people getting the same patterns as people getting used to. And we find really, at least in past episodes, which again haven't been as severe, there isn't this pent up demand that sort outweighs it over time. The amount of lock-in you've experienced in the past doesn't explain your probability to sell today. What explains your probability to sell today really is that delta, and I think on some level this makes sense if you have a 3% mortgage and you could get a 7% maybe a year ago, you're like, man, this seven percent's crazy, that's abnormal. What I have is normal. Maybe now you think the opposite. Okay, now we're in a 7% thing. I was really lucky to get 3%. In either case you have to pay $500 more a month if you go to a new place just based on that change in for the average borrower, it's $500. It doesn't really matter what you think is normal, it matters that you in some cases just can't afford to do it. So I think that's what we're seeing in the data. Again, having some humility about this is a really new situation, we're going to be learning a lot on the fly here.

Okay, alright. That's useful to me and I like to have humility with the data. I like to teach us actually what's happening and for example, watching expecting home prices to fall last year and then watching 'em climb was really interesting thing to pay attention to. So one element in this, the decay of the effect over time is we can see for example there's call it whatever, 50 million mortgages around the US and you do 5 million transactions a year. It's been two years, so there's 10 million people who are not locked in and we can for example, then every year that we see higher rates, we see those people are more likely to resell. It's actually consistent with the observation over time. So tracking available inventory over the last 15 years, we can see pretty much every year of the last decade rates falling lower, falling and available inventory low are falling as over the years we say, you know what?

(36:12)
I can get a four and a half percent. That was a good deal and I'm still not selling that house. So each year we take more homes out of resale, put 'em into second home investment and things like that. And I think a number I saw was about 8 million we did over the last decade took 'em out of resale and so we could see it at 10%, 8%, 20% drop each year in available inventory. And then when rates rise in 2018 to 2019, we see inventory jump a little bit and then we see starting in 22 inventory's climbing. And so from our side, from my interpretation, I see that therefore higher rates are the way we end. We essentially reset everybody over time, fewer and fewer people are locked into the ultra low rates. So higher rates over time essentially helps us decay the lock-in faster. And if rates were to fall, that means we add another 5 billion people who are locked in again because they have low rates. Is that counter to your conclusion?

So lemme respond to a couple things. First off, I think part of what we might be seeing is different patterns has to do with looking at a little bit different metrics. So we're really interested in our object is your probability of sale. So the number of transactions is sort of what we're

(37:53)
Predicting. We're not really predictable. We're seeing what influences that. Inventory is sort of a much more complicated dynamics going on there. Inventory can climb because there's a flow into inventory, people decide to sell, there's a flow out of actual transactions so they can climb because transactions slow down, but the flow in stays the same. So there's a lot more dynamics that can go into what's happening there regarding your other, yeah, so I guess I, I'm unaware of, I should actually know this other thing I wanted to respond to there is my item is not that there isn't any decay. We do see there are some transactions that go on now it's less than it was, but there are some, and over time more people will get reset into six, 7% rates and therefore they're not locked in by a six, 7% rate. In fact, if it drops to 5%, they have the slight incentive to want to sell if not refinance.

(38:55)
So there is a decay over time. The problem is is that whereas the overall historic average might be six year tenure and a loan, so something like 16% turnover year to year, we're at like 5% right now. So we're looking at a halflife of over 10 years in terms of just if we were to just stay here at De Valley now, I don't think we're going to stay here indefinitely if we're going to move in some direction, but to get rid of lock-in right now, we would put up a huge drop would be to get that effect down to zero where the average person is sort of in a neutral delta environment.

Great. And I want to ask you about then therefore the policy implications should we do that? But before we dive into that, should we do the policy questions? Help me understand and I appreciate your take. There's part of the reason we want to have this discussion is because what does lockin even mean? So we're talking about probability of sale of homes and so if we assume that say mortgage rates stay in the upper sixes for the bulk of this year, what do we think about home sales? Have you thought about they're starting to grow a little bit, we could see they're growing, I could see they're growing about 10% or so in the first quarter through the last week of March. What do you think? What should I expect based on the conclusions of the paper for 2024 and maybe even 2025? What should I think about?

Yeah, so I guess two things to keep in mind if you're sort of using our results to try to say, okay, what do we think is going to happen? So the most recent data we had was Q4 and we said the effect there was something like 57% decrease in sales with fixed trade mortgages. So that translates to less than a percent decrease if you're looking at something like the NAR existing home sales because first of all we're looking at arms, legs, transactions. So you bring in other types of transactions and you bring in transactions of people who own their house free and clear. Those seem to be less sensitive to rates. So you moderate that somewhat should moderate it a little bit more because as I said, Q4 was sort of the peak and we're probably down two thirds, maybe three quarters of a percentage point and rates today versus the average in Q4.

(41:51)
So you moderated some that way. But the other thing to keep in mind is that we identify this as a factor that influences your probability of sale. It's not the only factor. In fact, there's a chart in our paper that shows basically the sum of all other economic factors over time and that bounces around that is going to explain a huge amount. And so the lock-in effect isn't going to tell you anything about, that's whether outside of the lock-in effect, are we going to be in a good environment for sales or a bad environment for sales? What you can use our paper to say that though is that within the group, whatever sales are the people who are more likely to be selling are the ones who don't have a 3% mortgage that

Yeah, okay, that makes a lot of sense. And so it could be that this year starts to be like the other macro factors start to outweigh. For example, we have strong jobs market and we have more millennials in peak home buying age or those kind of factors could indeed drive. And in fact, I think one of the things that we observed this week in our weekly analysis was we can see home sales climbing seven to 10% now over last year. But some of the other indicators like the Mortgage Bankers Association has their purchase mortgages, the applications, the index for their applications rate, and that hasn't really shown growth yet over 2023. And one hypothesis there is that we are indeed seeing more cash buyers now we shift to more cash buyers. And so those cash buyers are less likely to be locked in as you're pointing out. And so these other factors could develop more and maybe they take over more in the 2024 numbers.

So in economics we're always throwing around this term RIS previous which just Latin, all else being equal and that's what our results are, right? All else being equal, this lock-in decreases sales was 50% in the fourth quarter. Maybe we're at 30 something percent based upon where rates have gone to the first quarter, but everything else is not equal. What this is saying is that sales of homes that had a fixed rate mortgage are 30 or 50% less than they would be if we were in a world without lockin because everyone had arms or everyone had a portable mortgage. Or we can talk a little bit about different policies that get around this, but it's sort of comparing that counterfactual world with the world we have today.

Terrific. Okay, that's really useful for me. I appreciate that. You mentioned real quick arms, this is all nerdy technical, but I loved how you use the arm versus a fixed rate mortgage and measure how frequently sellers who have arms continue to sell versus sellers who have fixed mortgages stopped and we could watch that delta pre pre lock in and post lock-in and see the change there. Super useful there. That was like, oh, that's a real clever way to track because fixed rate, adjustable rate mortgages aren't locked in.

Yeah. Economists are always picking apart each other's results and saying, well, did you consider this? Did you consider that? And I think the most convincing feedback that we've gotten, that the most convincing thing is, well, if your result was really due to you didn't consider this or that, then it would show up for adjustable rate mortgages. And what we see is that that relationship doesn't exist for adjustable rate of mortgages right now. Someone who has an arm that's passed their fixed rate period, they're as likely to sell as they would as they ever are.

Got it. And it doesn't matter that the folks who take arms, especially who took arms in the last decade did so because they probably were already more likely to sell.

Yeah. So I should say yeah, the baseline sale rate for people with arms is much higher than the baseline sales rate for people with fixed scrape mortgages. And the arms we have are hybrid arms. If you choose a five one arm versus a seven one arm time, one arm, that probably says something about your expected holding period when you buy. So we're not making a claim that they are more likely to sell and always more likely to sell regardless of what happened with the interest rate environment. The differences is once you're past your fixed rate period, the interest rates, the interest rate environment that you exist that existed when you took out that mortgage no longer really affects your probability to sell now, which with an adjustable rate mortgage makes sense because the interest rate environment that existed when you took up the mortgage isn't determining your interest rate now. So it must be for fixed rate mortgages, it must really be that they have this low rate mortgage and not because people who bought a refinanced in 2021 were just the type of people who are always going to stay put.

Okay, terrific. That's really neat. I like that. I thought that was a really clever way to help. How do we know likelihood to sell and turns out we can measure that comparison. So that was really neat. Let's shift to policy. In the paper you suggested a couple of things, likeability of mortgages, some of those things. And I've had folks especially in the mortgage industry or the real estate industry, mention things like assumable mortgages to me as a potential policy and change remedy for the lock-in effect. Tell me about your thinking about policy before I shoot my mouth off about my thinking about policy. Yeah,

So I want to be clear on this. We're very careful in the paper. We're not endorsing any particular policy solution. Our goal is to better inform the conversation, give policymakers and other researchers some of the information they need to evaluate the pluses and minuses of these different options and to evaluate the size and scope of the problem that these would be aimed at addressing. Now in doing that we sort of lay out the menu of policies and market features that have been used in the past in the US or exist in other countries that could help avoid locking. So one of those isum ability, which actually does exist in the US for FHA and VA and USDA loans can technically be assumed. Unfortunately the takeup has always been and continues to be very, very low on this option. So the Wall Street Journal reported 6,400 total assumptions for FHA and VA loans in all of 2023.

(49:41)
And 2023 would be the banner year for assumptions. It's when you have the most incentive to do so. And there's been some reporting and anecdotal stuff about why this is so low. The other problem, withum ability beyond its low takeup where we've seen it is in theory the way assume ability should get around this is you can get paid for your low rate, it'll increase the price you can get for your house. If your house comes with this low rate mortgage, it's suddenly not very valuable. Other researchers have looked at this and found that you only recoup about a third of that value. So that $3 trillion that people have, they could get 1 trillion, they could get a third of their share of it if they could sell their mortgage, which would help. But that's not going to get rid of all of it because you can't recoup all of it.

(50:38)
So the other things we discuss, adjustable rate mortgages don't have this feature, but again, there's pluses to that, there's minuses to that in countries that have adjustable mortgages, the UK for instance, you are very at the whim of interest rates your budget can get, there's big shocks to it. So there's costs, there's things to consider as being a mining on that. Portable mortgages is a little bit different and Canadian mortgages work this way and among other places where you can change the collateral that underpins your loan, the is to you and you can move it to your new house if you want to. So that has some promise. But one thing we note in the paper is that for all these solutions we would need to understand portable mortgages was the rural interest rates probably would not have been 3% in 2021 if they knew that you could take it with you.

(51:46)
So I think that's an area for future research to understand what are the general equilibrium ramifications to having more widely assumable or portable mortgages and what would that mean to the interest rates that are being offered over time? Maybe it would be a feature, maybe you could say yes, there'd be less, it wouldn't have been as low in 2021. There'd be less volatility overall and there'd be less of a crapshoot of when you happen to be getting married or wanting to have all these life events happening, what interest rates happened to be at that time would have less of a bearing on how well lost you are. But these are areas that I think we need to research more and understand more because this is probably not the last episode of lock in. We will face and want to better understand the policy arsenal to face feature ones in addition to this one.

That's terrific and thank you for that insight. I didn't realize there's only 6,400 assumptions, mortgage assumptions, what should have happened. But so if I'm selling my house, I get more money for the house, but I only get a third of the value, it's like I'm only getting a third of the value of not selling my house, of holding onto that. You can imagine why people wouldn't be motivated to sell if they sell already. They maybe say, oh, I can get a little more. That's fascinating. You might've guessed based on my interpretation of the process where higher rates for longer are what end the lock-in for us because we reset everybody's rate higher, the average rate is reset higher by 5 million people a year is do you have a thought on understanding, you're not endorsing, but do you have a thought on what if we assume the policy should be to essentially let rates be higher for longer to as a means to unlock the market? Am I nuts?

Well, so yeah, I want to do two steps on this here. We're definitely careful on housing policies about policies that we don't endorse a particular way, but we talk about different ways policies could avoid the lock in effect where interest rates should be touch a whole lot more than just housing. So we definitely wouldn't want to say rates should be this or that just because of lock in effect. Because there are considerations that go outside of housing on what interest rates should be. So yeah, the goal of interest rates are not just to have a healthy housing market. In fact, maybe sometimes the trade off is let's have an unhealthy housing market, but that'll help us on some other policy dimension, be it employment or inflation. So yeah, I would be very careful. Definitely don't want to recommend us go one direction or other on rates just because of our findings. Unlock it.

Fair enough, fair enough. That's really great. We we're at the hour, it's terrific conversation. So let me just do one sort of broader question about housing, which I think is work that you've done, which is on the topic of affordability, it's related to what we're talking here and we've had a crisis of transactions and we also have a crisis of affordability as rates climbed and as we pointed out, early rates climbed and home prices climbed. Do you have a view, I'm very interested in housing affordability in this country and will we ever get affordable and do you have a view on affordability and what we might, some ideas that might help shape my thinking on it?

Yeah, so I know it's kind of trite to say, but ultimately price, which is affordability or a component of affordability is a function of supply and demand. So if we want more affordability, if we want lower prices, we need either less demand or more supply. So less demand would mean lower population, less household formation or less demand per space per household. And I don't think very many people would say that any of those are likely or even desirable in some cases. So ultimately we're left with this supply and our paper looks at one thing that's holding back the supply of existing homes right now, but in the medium and long term new homes is going to be the determinant of supply. So in the medium term, we need to be thinking about things that will allow affordable housing to come to the market and in the longer term probably things that allow all types of homes to come to the market now can help longer term.

(57:14)
And there are topics I'm deeply interested in, things that I am continuing to research about what are the constraints that really are binding right now? What are the things that are keeping all types of new construction both explicitly affordable and not affordable market rate and large homes from coming to the market. But one thing I will say that I think is a positive of coming out of this affordability crisis that we find ourselves in is that I think I have noticed a shift in the way politicians and policymakers talk about home prices in general because it used to be talked home, prices used to really be talked only through the lens of it being an investment. And so much of the conversation was protecting home values and now we're talking about it more as a consumption good and about having it be a good that's affordable to most people or all people. And I think that's a positive and I think that's regardless of what policies ultimately are most important for helping supply, there needs to be the will to do it. And I think shifting our mindset away from it being this investment to it being something that we consume is an important step in being able to implement those solutions.

That is a terrific way to look at it. I appreciate that very much. And I too sense the shift in policy and construction policy. I live in San Francisco and to shift that thinking is a big deal to to new construction and there's still a lot of folks who fight it, but you can see it underway. So I share that and so it's nice to think about that as an optimistic turn for future affordability for the folks who don't yet own homes in this country. Yeah, terrific. Well, Jonah, thank you so much for sharing your expertise and steering me in the right direction and new directions on how to think about what's happening in the market. The paper was outstanding. It's kind of a page turner. I was looking for reading the next page. It was really great. And so we will include a link to the paper in the show notes for anybody here. Do we have anything else where they can follow you? Are you on social media? I know Will Doer and I was one of the authors on the paper, our Twitter and LinkedIn colleagues. How about you? Any place that people can follow you or follow you work? Yeah,

I'm on Twitter. It's probably not as active as Will, but as I said, as a co-author here, it's just my name Jonah Cost. So you can look me up there and certainly just tell people to keep an eye on our working paper series that's on the FHFA website because there's plenty of other research like this about other topics that comes out and it could be interesting to folks.

Jonah Costa, it was a real pleasure. Thank you for taking the time with us today. I appreciate it very much everybody. This is the top of Mind podcast. If you need to learn more, go to altos research.com. We can talk about data. But really if you like the podcast, I appreciate, always appreciate a review so that it helps other people find the work we're doing here and we're really doing it because it's really such a joy for me to learn from the experts in the world. And as we say, stay humble so we can understand what the data's actually telling us. So Jonah, thank you so much for your time today