Opinion | Most homeowners are both richer and poorer than they understand

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Most current homeowners are both richer and poorer than they understand. The result is a seriously deranged housing market.

They are richer than they feel because people who bought before 2022 enjoyed record low interest rates when they bought or refinanced. As late as November 2021, the average rate on a 30-year fixed mortgage was 2.98 percent. Last week, it was just a hair under 7 percent.

Those homeowners are aware they got an exceptionally good deal (rather smugly aware, in fact). But they don’t think of that ultralow rate as an asset, like their 401(k) or their home equity.

Yet in a real sense, the value of their mortgage has risen — something that would be obvious if there were some way to sell it. People are willing to pay a good penny to borrow at below-market rates (as homeowners do every time they pay mortgage discount points to get a lower rate). If there were some way to pass their ultra-low rate onto someone else, they’d have a valuable asset.

Back in the 1970s, during the last Great Inflation, homeowners could have sold that rate reduction to anyone who bought their house. But banks didn’t like that; they were stuck with low-interest-rate mortgages while the rates they had to pay on savings accounts were soaring. That disconnect contributed to a massive crisis in the savings and loan industry. Most lenders started inserting “due on sale” clauses into mortgage contracts to force people to pay off the mortgage when they sold the house.

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Nowadays, this has created a paradox in the mortgage market. Mortgage holders took a real loss as rates fell. The S&P index of mortgage-backed securities is now down about 11 percent from where it was in December 2021. But no corresponding gain is buoying homeowner balance sheets, because homeowner’s windfall has no market value — the only way to realize the gain is to squat in their house until the mortgage is paid off.

And so far, that’s exactly what they’re doing. Since February 2022, the annualized pace of existing-home sales has fallen 40 percent, from 6.3 million to 3.8 million.

Which leads to the second oddity: stubbornly high prices. Currently, the median sales price of an existing home is $391,800, down slightly from its June peak of $410,000, but up significantly from $358,000, where it stood in December 2021. Of course, median household incomes have risen too, but not nearly enough to cover the additional $1,000 a month it would cost to finance the more expensive median home at the much higher average interest rate.

House prices should be falling to counteract higher rates. Instead, prices have stayed high while supply has contracted, as existing homeowners, unwilling to give up their cheap mortgages — or accept less for their house — simply froze in place. With so little supply, the remaining buyers are forced to pay a premium.

That’s why those homeowners are also poorer than they think. Theoretically, their homes are worth almost as much as they ever were. But if a normal number of them tried to sell their houses, prices would fall toward something more people could afford.

One way or another, housing prices and the incomes of potential homeowners must be brought back into balance. The best way for that to happen, of course, would be for homeowner incomes to shoot up sharply — about 25 percent should do it. And if you know any surefire way to make that happen, you should write to President Biden, care of his White House Council of Economic Advisers.

Alternatively, falling interest rates could perk up buyer demand. Last week, the Fed signaled that it’s done tightening, and Fed watchers think it might even loosen up a bit next year, which means mortgage rates should fall, too. But today’s prices reflect a unique time in the market: not just record-low rates but also a sharp spike in household savings during the pandemic. That savings bulge has already been spent down, and it’s unlikely that we’re going back to the sub-3 percent mortgage any time soon. So prices still probably need to adjust in a downward direction.

Eventually, of course, inflation will take care of the problem for us. But at 2 or 3 percent annual inflation, which is the Fed’s target, that adjustment could take years of people pinned down in the wrong house — too far from work or the right schools, too big for empty-nesters, too small for a growing family. Developers can pick up some of the slack by building new homes, at least for first-time homeowners who aren’t encumbered by the golden handcuffs of a low-rate mortgage. But housing starts have actually fallen since April 2022, as higher interest rates ate into demand and made construction more expensive — on top of the zoning codes and other regulatory red tape that push up the cost still further in the most desirable locations. This raises the cost of new housing above what many aspiring first-time homeowners can afford to pay.

So what to do? I have a fantasy where we figure out some way to make a deal with homeowners: sweep away the zoning and other local barriers to building new homes, and we’ll get servicers to rewrite those “due on sale” clauses that are keeping you from unlocking the hidden value of your mortgage asset.

Unfortunately, I don’t see any way to make that deal. Obviously, the people who own those mortgages would object. More importantly, any such deal would have to be made at the national level, while most of the barriers to building are erected by state and local government. And so we’re likely to resolve the housing market’s dysfunctions in the worst possible way, with everyone hunkering down where they are until some combination of Fed policy and necessity finally brings supply and demand back in line.

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