Record low mortgage rates are now a major problem for homebuyers. Here's why

Too many homeowners have done that affordable mortgages that are worth keeping, which is a problem for the housing market.

In addition to the high mortgage interest rates and steep house prices, the lack of existing homes for sale keeps new buyers on standby. In a recent one CNET Money survey13% of American adults said access to more inventory would help them consider buying a home.

The limited housing supply is partly due to the ‘rate-lock effect’. Homeowners in lockdown historically low mortgage rates at the start of the pandemic they can’t afford to increase (in some cases even double) the interest rates on their home loans, so they stay put.

Fewer sellers mean few options for buyers looking for homes on the market. “It’s brutal, it’s really tough,” says Maja Sly, a real estate agent with Keller Williams.

The Federal Reserve is expected to achieve its goal second interest rate cut this year on November 7 by a quarter of a percentage point (0.25%). But don’t expect dramatically lower mortgage rates anytime soon. After the Fed’s first interest rate cut in September, mortgage rates even rose to almost 7%. The central bank’s interest rate decisions influence, but do not directly determine, the interest rate on home loans.

It will take several months of weaker economic data and additional Fed rate cuts before mortgage rates drop significantly. If that happens, however, more homeowners could start packing and moving, potentially freeing up more inventory.

Limited housing stock and high house prices

The rate-lock effect leads to a shortage of housing supply in a number of different ways. Some homeowners with low interest rates simply don’t do that want to to sell their home even if they can afford to buy a new one.

But more often than not, persistent inflationary pressures and the high cost of living make it impossible for many homeowners to move even if they want to, Sly said. Those with one 2.5% interestfor example, would see their mortgage costs skyrocket if they bought a comparable home today, and not just because of current rates. House prices have also increased by 47% since the beginning of 2020.

“Housing prices and inflation are really outpacing incomes,” Sly says.

In the CNET Money survey45% of American adults said falling home prices would play a role in their decision to purchase a home. In other words, buyers are sensitive to high sales prices and houses don’t fly off the shelf, says Vickey Barron, a real estate agent at Compass.

Moreover, prices are caught in the crosshairs of supply and demand: with many buyers and few available homes, prices are driven up. Sly says many sellers feel they can jack up prices even if the quality of the home doesn’t warrant it. And sometimes they can get away with it, especially when people move from expensive markets to cheaper cities and don’t mind paying.

Another big problem for the housing market? Sellers are usually also buyers. So even if the interest rate lockout effect diminishes, sellers looking for homes for sale could increase competition and drive prices up.

The other side of the housing inventory is of course the brand new housing construction. In the past year, newly built homes have become an increasingly popular option for buyers who can afford them.

What does it take before homeowners can start selling?

Although the Fed’s 0.5% Rate Cut September is good news. Experts agree that this is not enough to get the housing market out of this impasse.

“It’s very positive, but it’s not going to be a tsunami of sellers right now,” Barron says.

Fed Chairman Jerome Powell also acknowledged this in his comments of September 18 after the rate reduction. “As interest rates go down, people will start to exercise more, and that’s probably already starting to happen,” he said.

But he warned that a bigger problem is that the country is not build sufficient new homes to increase overall supply, which would also take pressure off house prices. “This is not something the Fed can really solve,” Powell said.

Sly said mortgage rates need to drop back to the 4% mark before people can start selling and moving into new homes. Half of American adults in the CNET Money survey said a mortgage rate of 4% or lower would allow them to realistically consider buying or refinancing a home.

And a significant 29% of survey respondents said there is no mortgage rate that would allow them to realistically purchase or refinance a home. This highlights the challenges associated with low inventory, high house prices and inflation, regardless of interest rates.