Downside of low mortgage rates? Less selling

WASHINGTON - Would-be home sellers across the country are grappling with a once-in-a-lifetime problem: They have mortgage rates so absurdly low it would hurt them financially to sell.

Doing so would mean giving up an irresistible rate in exchange for a new mortgage carrying a rate up to a percentage point higher. Their monthly payments would be larger even for a house of the same price. That's discouraging some people from selling, thereby limiting the supply of available homes and contributing to slower home sales.

It's a significant shift from the way the U.S. housing market has worked for the past 30 years. For most of that time, whenever a homeowner decided to trade up to a better home, mortgage rates usually were lower than the last time they had bought. That helped make a new purchase seem more attractive.

But that is changing. The average rate on a 30-year mortgage fell below 4 percent in late 2011 and reached a record low level of 3.3 percent in November 2012. It didn't top 4 percent again until mid-2013. Homeowners took advantage of the lower rates and a refinancing boom ensued.

More than one-third of homes with a mortgage now have rates below 4 percent, real estate data provider CoreLogic estimates. Yet mortgage rates now average 4.2 percent. That is still low by historical standards but up about three-quarters of a point from a year and a half ago. And should mortgage rates rise later this year and next, as many economists expect, even more homeowners will be affected.

As a result, many homeowners with low rates are staying put. Others are moving and buying new homes, but keeping their old ones and renting them. Both choices mean that fewer homes are listed for sale, which drives up prices. Higher prices and limited selection have put the brakes on a housing recovery that began in 2012.

And slower home sales, in turn, drag down economic growth. Fewer sales mean lower commissions for real estate agents. Sales of furniture, appliances and garden supplies also take a hit.

Mark Fleming, chief economist at CoreLogic, estimates that as many as 3.6 million homeowners are unlikely to sell this year because they would have to give up a lower rate.

"They got the deal of the century," says Glenn Kelman, CEO of real estate brokerage Redfin. "I don't think in 100 years anyone will be lending money at 3.5 percent. How do you walk away from a deal like that?"

You'd think Ryan Carson, an attorney in Seattle, would be ready to sell. He and his wife have one young child and they are expecting twins. They are going to hire a live-in nanny, which means there will be five people living in their four-bedroom house.

"I could probably use the extra space, honestly," he said. And he would make money off the sale, since his home's market value is above what he paid.

But Carson, 39, has a 30-year, 3.85 percent mortgage rate, so he isn't going anywhere. He refinanced into the lower rate last summer, reducing his monthly payment to $2,200 from $2,600.

"I have no interest right now in selling," he said. He and his wife plan to remodel instead.

A shortage of homes for sale has plagued the housing market since late 2012. The number of available homes last year was the equivalent of just 4.9 months' worth of sales, according to the National Association of Realtors. That's far below the typical figure of 6 months. Inventory has recovered somewhat this year, partly because the spring buying season is underway, but it was still equal to just 5.6 months of supply in May.

Meanwhile, sales of existing homes have fallen 5 percent in the past year. Yet prices rose 8.8 percent nationwide during the same period, according to CoreLogic, partly because of the limited supply.

What economists call "rate lock-in" is one of several reasons so few houses are for sale. Another factor is that almost 40 percent of homeowners still don't have enough equity to enable them to sell. Some are "underwater," with a mortgage higher than the home's value. Others may have so little equity that they can't afford to pay off the sales costs and put a down payment on their next property.

"We are in a uniquely difficult period for matching buyers and sellers," says Stan Humphries, chief economist at real estate data provider Zillow.

Home prices are expected to keep rising in the coming months, though at a slower pace than the double-digit gains that occurred earlier this year. Higher prices should lower the number of underwater homes and enable more people to sell.

But as the number of underwater homes falls, several studies suggest the impact could be offset by higher mortgage rates, which would increase the number of homeowners facing interest rate "lock-in." Most economists expect mortgage rates to rise later this year as the Federal Reserve ends its bond-purchase program, which is intended to keep borrowing rates low.

"Mortgage rate lock-in is going to be a major challenge for the housing market going forward," Humphries said. "It is going to be a constant tug of war between buyers on one side ... and mortgage rate lock-in on the other side."

Humphries forecasts that rates will reach 5 percent by the first three months of next year. That would mean those buying or refinancing now, at the current rates of about 4.1 percent, might never want to sell either.

A 2011 study by the Federal Reserve Bank of New York concluded that for every $1,000 increase in a homeowner's annual mortgage payment, the likelihood that homeowner would sell fell as much as 16 percent.

Paul Bernard, a recruiter in New York City, says the issue has begun to interfere with some of his clients' willingness to move for a new job. In one recent case, an employee at a large technology firm decided to postpone a job-related move to San Francisco partly because it would have forced him to take out a mortgage at a half-percentage point higher than his current one.

"The job market in some cases is less mobile than it used to be," he said.

Low rates have combined with rising rents nationwide to make renting out a home, rather than selling, more attractive. A rental index compiled by Zillow has risen 19 percent in the past year.

Santiago Garcia, 30, and his wife both work from home and recently felt their 2-bedroom condominium was getting cramped. The couple was also thinking of starting a family. So in February they bought a new home in Oxford, Massachusetts, about 45 minutes from Boston.

But the mortgage rate on their condo is just 2.95 percent, so they decided to keep it and rent it out. The mortgage is so low because its rate is adjustable after 10 years.

Their monthly mortgage payment is only $540. But they are renting it out for $1,200 a month.

"The cash flow was so much, it was an easy decision," Garcia said.