What Is the Lock-In Effect and How Does It Affect Home Buying?

Quick Answer

Not to be confused with locking in a mortgage rate, the lock-in effect refers to homeowners choosing to stay in their homes when they otherwise might have moved. With interest rates growing at an aggressive rate, homeowners may feel locked in to remaining in their homes, since moving could significantly increase their housing costs.

Woman longingly gazes out the window of her home

In 2022, interest rates catapulted to levels not seen since 2008 amid the Federal Reserve's clampdown on inflation. The higher rates came after nearly two years of record-low rates that many homebuyers were eager to capitalize on.

The recent rate spike has resulted in what observers call the "lock-in effect." The lock-in effect reflects how high mortgage rates disincentivize current homeowners from selling their home since many would prefer to avoid a more expensive mortgage on a new home. The lock-in effect restricts housing supply and may price prospective homebuyers out of the market by contributing to increased costs for the homes that are put on the market.

Let's examine the lock-in effect and how it might affect your ability to buy a home.

What Is the Lock-In Effect?

The lock-in effect, not to be confused with rate-locking a mortgage, refers to homeowners who are reluctant to sell their homes amid rising mortgage rates because they have a low interest rate locked in.

According to a Redfin analysis of Federal Housing Finance Agency (FHFA) data, 85% of homeowners with a mortgage have a rate lower than 6%. On top of that, a Zillow estimate of 2019 Census data found that 37% of homeowners own their homes outright and don't have to worry about a mortgage at all. Unsurprisingly, even homeowners who experienced significant equity gains during the pandemic-era housing boom are reluctant to increase their housing costs, since the interest rate could be up to two times higher than their current rate. The average 30-year fixed-rate mortgage interest rate as of December 1, 2022, was 6.49%.

The lock-in effect is not a new phenomenon. Here are a couple of examples of the lock-in effect in years past:

The Housing Market of the 1980s

At that time, homeowners elected to stay put and pay off their existing low-rate mortgages, according to a study by the Institute for Housing Studies at DePaul University. Remember, 6% rates were considered "good" then, and would-be sellers decided to stay put once interest rates skyrocketed.

Over a three-year period from 1978 to 1981, the average monthly rate on a 30-year fixed-rate mortgage spiked from 10.1% to 17.8%. As rates grew higher, fewer homeowners moved, according to the DePaul study.

California Proposition 13

Prop 13, enacted in California in 1978, limits property taxes to a maximum of 1% of the full assessed value on a home (plus additional locally imposed rates). Additionally, annual increases in assessed value cap at the lesser of 2% or the state's consumer price index growth rate.

Consequently, if your property value increases by more than 2% a year, you may be incentivized to stay in the same home because your taxes would be lower than they would be in another home of equal value. Indeed, a Library of Congress study found the average ownership period of properties climbed by 1.04 years from 1970 to 2000.

How Does the Lock-In Effect Impact Buying a Home?

The lock-in effect is contributing to a 19% drop in new listings, according to the Redfin report, the biggest decline since May 2020. Homeowners want to keep their current low-rate mortgages since opportunities for cheaper financing or suitable housing disappear when mortgage rates and home prices rise.

The drop in new listings is limiting the housing supply and keeping home prices relatively high despite a cooling in the market. The Redfin report notes that the housing supply dipped 1% from July to August 2022, while supply would experience an uptick under normal conditions.

If you're looking to buy a new home, you may find limited inventory and higher prices. A shortage of new inventory has been a significant factor in home prices staying near record highs.

Also, keep in mind, the lock-in effect impacts buyers as well, since higher rates price some sellers out of the market, and present fewer listings to choose from. That means you may find some homes remaining on the market for longer, although declining inventory is driving homes to sell in 21 days on average, according to the National Association of Realtors.

The Bottom Line

The lock-in effect is a contributing factor to declining inventory, as buyers and sellers alike opt to stay put until mortgage rates are more favorable.

If you're waiting for better conditions before making your move, you can still take advantage of this time to prepare your credit for a home purchase. Evaluate your credit score and credit report to get a clearer view of your credit health. If necessary, take the appropriate steps to improve your credit before you apply for a new mortgage.