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'Lock-In Effect' Looms as Rising Mortgage Rates Bring Lower Sales

NEW YORK (TheStreet) — Just as it looks like the housing market is gaining strength, a new boogeyman may be emerging: the "lock-in effect."

That's when rising mortgage rates make homeowners unwilling to sell, because they don't want to trade an old, low-rate mortgage for a new one charging more.

According to a report by HSH.com, a mortgage and housing company, the lock-in effect is becoming a hot topic among real estate experts who fear its impact on the economy

Homeowners who succumb to the effect are reluctant to move for a better job, new school or to get more space for a growing family. That would reduce demand, dampening gains in home values. It would mean less business for real estate agents, builders and sellers of home furnishings and appliances ... Well, you get the picture.

The problem is the flip side of government efforts to stimulate the economy by driving mortgage rates down from more than 6% to below 4%. Since April 2009, about 28 million homeowners have refinanced to get lower mortgage rates, according to government figures. Millions more bought homes with low-rate mortgages. Many of the 30-year loans charged as little as 3.5%, and ones with shorter terms charged even less.

HSH noted that a recent study by the Institute for Housing Studies at DePaul University in Chicago found that a 10% increase in households bound by the lock-in effect would reduce housing turnover by 29%, a huge drop in sales.

The big question is how much higher mortgage rates will go. Though they are now slightly higher than a year or two ago, many experts had thought they'd be even higher by now. The rate increases have been enough to destroy the refinancing binge, since refinancing now doesn't offer enough saving to offset the cost. New federal mortgage rules have made it tougher for mortgage applicants to qualify, reducing the number of new loans approved. These and other factors have left lenders hungry for business, discouraging them from raising mortgage rates. 

Also contributing to the lock-in effect is the sluggish growth in wages. People are less inclined to take on bigger monthly payments if they don't think the burden will become easier to shoulder over time.

For a homeowner, the consequences of higher rates are stark. At 3.75%, a rate obtained by many during the refinancing boom, principal and interest cost $463 a month for every $100,000 borrowed. Raise the rate to 6% and the cost zooms to $600 a month.

Paying more to borrow obviously changes the calculation when a homeowner considers moving. A move for a better job or school could well make sense even if housing would cost more. But a move would be tougher to justify if the only result was a slightly nicer neighborhood, or to keep up with the Joneses.

And as rates go up, those who feel compelled to move may face an unwelcome option: buying a new home that's less expensive than the old one,  and perhaps not quite as nice.

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