Emerging Business Leaders Program

The Merriam-Webster Dictionary defines tumultuous as “(adjective) marked by violent or overwhelming turbulence or upheaval.”

And the word tumultuous could easily describe how mortgages have been acting over the past several years. Finding a way to examine this up and down terrain of mortgages has been part of the research work of Julia Fonseca, assistant professor of finance at Gies College of Business. Together with Lu Liu of The Wharton School, University of Pennsylvania, Fonseca has been examining this tumultuous terrain of mortgages and the very real impact that they can have on families.

Fonseca and Liu wrote a working paper titled “Mortgage Lock-in, Mobility, and Labor Reallocation,” which examines the impact mortgage rates have on labor reallocation and mobility. In other words, what effect do mortgage rates have on the decision-making process when an individual is considering moving – in particular for new job opportunities.

One unique feature of the US mortgage market is the ability to lock in interest rates for as many as 30 years. Since around 1990, there has been a gradual but steady downward trend in the mortgage rate. According to Fonseca, by March 2023, about two thirds of borrowers had locked in a mortgage rate that was under 4 percent.

This gradual decrease, though, has changed dramatically in recent years. “It was the tightening cycle of 2022,” Fonseca said. “Interest rates had been low and broadly declining for decades. But rates started rising very substantially.”  The interest rates on mortgages increased, raising the monthly payments for new mortgages.  

In addition to increasing the cost of owning a home, these increases could affect workers’ advancement. If someone had the opportunity for a new job, but would need to move, these rate increases would have a significant, measurable impact on workers’ mobility. “If you move, you have to pay off your loan at this very low rate and take on a new loan at a new rate, which can be very costly,” Fonseca said. “For the typical borrower, a one percentage point rise in rates increases payments by about $1,900 a year. If you have 20 years left on your mortgage, and you don’t refinance later on, that means that the present value of the payments you are going to make on your mortgage are going to increase by about $27,000. That’s a lot of money. And that creates a strong incentive for people not to move.”

As Fonseca’s research indicated, the greater the difference between a mortgage rate a homeowner currently has and the rate they would need to get if they moved, the greater the financial impact on the workers. This was an incentive to not move for the new opportunity. It was financially advantageous to stay where they were. This suggests that lock-in is preventing them from pursuing these labor market opportunities that would have been worthwhile otherwise. It could keep workers from finding the best jobs. It could keep firms from finding the best workers. And so that could have real consequences for labor markets and labor productivity.

How decreases in interest make an impact

Fonseca said that that reducing interest rates would have an impact on worker mobility – though less pronounced. “As rates decline, borrowers get less locked in, and they are more likely to move, but only up to a point,” she said. “Because once rates get low enough, it becomes advantageous to refinance.” Once interest rates decrease to the point where refinancing could be advantageous, the relationship between interest rates and moving disappears.

The impact of lock-in on housing availability

In addition to higher mortgage rates motivating people to stay in their homes – and not move – these factors can also impact available housing in a community. It would reduce the supply of homes available to first-time home buyers. Fewer houses can also drive up housing prices. “And that might even be a factor in explaining why house prices in the US have not declined much while in other countries, they were really seeing house price declines,” Fonseca said. “If no one is putting their homes up for sale, that doesn't just affect the person who is not upgrading to a better home.”

This problem was recognized by the White House which recently proposed establishing tax credits that would encourage homeowners to sell their starter homes, making them available to those seeking a first home. A couple of difficulties with this proposal, according to Fonseca, are that in order for someone to sell their starter home, they need to have another home to buy – and the owner of that house may be reluctant to sell due to the mortgage rate they have locked in. Also, the tax credit isn’t very large relative to how valuable low mortgages are to borrowers. She said in a thread on X, “The maximum tax credit of $10k is small relative to this amount, so it might not be enough to incentivize even one seller to sell, let alone two.”