In the midst of a pandemic and economic uncertainty, the housing market has been surprisingly resilient. Contrary to expectations, home prices have continued to rise, and competition remains fierce. The reason behind this unexpected trend lies in the cost of upgrading to a nicer home.
According to data from CoreLogic, home prices in February were 5.5% higher than they were the previous year. This may not seem significant at first glance, but when considering that the average price gain from January to February was nearly twice what is typically seen during that time of year, it becomes evident that the Spring market started off strong. This is despite the fact that mortgage rates have risen, which usually cools the market.
The real problem in today’s housing market is the lack of supply. While there are more new listings this year compared to last, overall supply is still 40% below pre-pandemic levels. This shortage can be attributed to a phenomenon known as the lock-in effect. Many current homeowners are deterred from listing their homes for sale because the cost of moving up to a nicer home is prohibitively high.
In the past, upgrading to a home that is 25% more expensive would have increased the average homeowner’s monthly payment by 40%. However, with today’s low mortgage rates, that increase jumps to a staggering 132%. For example, moving up to a more expensive home in Buffalo, New York would add $604 to a homeowner’s monthly payment, while in San Jose, California, the increase would be a staggering $4,517.
Lowering mortgage rates would certainly make moving up more reasonable for many homeowners. If rates fell to 6%, the average monthly payment increase for upgrading to a 25% more expensive home would ease to 88%. While still higher than the long-term average of 39%, this improvement could motivate those with a pressing need or desire to upgrade. If rates fell to 5%, the increase would be 68%, which is still higher than the long-term average, but could potentially entice more homeowners to make a move.
It is worth noting that not all borrowers have record-low rates, but those in pricey markets are more likely to have lower rates due to refinancing. However, moving up to a higher rate would still be costlier for them. This is why the lock-in effect is particularly strong in expensive areas like California.
Despite the fact that the majority of borrowers today have rates below 6%, the housing market still faces challenges due to high and rising home prices. A recent report from Zillow reveals that the U.S. now has a record-high 550 “million-dollar” cities, where the typical home is worth $1 million or more. This is 59 more million-dollar cities than there were in 2023 when rising mortgage rates were causing home values to weaken.
In conclusion, the cost of upgrading to a nicer home has had a significant impact on the housing market. Despite higher mortgage rates, home prices continue to rise, and competition remains fierce due to a shortage of supply. The lock-in effect, caused by the high cost of moving up, has deterred many homeowners from listing their homes for sale. Lowering mortgage rates could potentially ease this effect and make moving up more reasonable for homeowners. However, given the current high and still-rising home prices, the housing market continues to face challenges in terms of inventory and affordability.
