3% Mortgage Rates: Gift of a Lifetime or Low-Rate House Arrest?

For many Americans, homeownership became a reality during the years of ultra-low mortgage rates following the 2008 financial crisis, an environment that essentially lasted all the way up until the Federal Reserve's campaign to raise interest rates, which started last year. Many were even able to take advantage of refinancing opportunities as recently as 2021 or late 2020 when rates dipped below 3%. In fact, over 50% of all outstanding mortgages originated in 2020 or after.

That interest rate dynamic has now completely flipped on its head. Had you been fortunate enough to be able to buy or refinance during that low interest rate period, you are likely counting yourself lucky. For many, that low fixed rate now feels like a gift that keeps on giving.

However, that is not necessarily the case for everyone. For some, it may also start to feel like a sort of low-rate-induced house arrest — they feel trapped in their home.

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The average 30-year fixed rate mortgage was 3.1% at the start of 2022. It has now approached 7%. The ability to relocate is starting to feel more like a far-fetched idea rather than a viable opportunity. The math for many no longer works.

Take for example the hypothetical homeowner who wants to move closer to family. They own a $500,000 home with $200,000 in equity. If they sell their home and buy a home of similar value, giving up their 3% mortgage and replacing it at the 7% rate, the new principal and interest payment on that $300,000 mortgage has gone up 58% from $1,265 to $1,996.

Mortgage Rate Math Doesn’t Work for ‘Move-Up’ Buyers

The math for a “move-up” buyer? It simply doesn’t work out. If that same homeowner instead was looking to buy a $600,000 home (so 20% more house), that would mean their monthly payment would go up 110% from $1,265 to $2,661. This is ignoring any increases in property tax or insurance.

Even those looking to downsize won’t catch a break in this new world of higher rates. Take the prior example, but this time consider an elderly homeowner who is struggling to maintain and get around in their larger home and is seeking to relocate to a smaller $400,000 home. Despite reducing their mortgage balance from $300,000 to $200,000, their new monthly payment will have increased from $1,265 to $1,331.

These higher rates have definitely put a damper on home sales, which are down about 23% over the last year. However, despite this fall in the number of sales, prices are essentially flat since this time last year. Homeowners reluctant to give up their low-rate mortgages are certainly a contributing factor, limiting supply. 

The longer these high rates persist, we can expect more significant ripple effects throughout the economy, particularly in the context of limited job mobility. This dynamic could prove troublesome, especially in combination with the continued tight labor supply. Consider a homeowner seeking to move for a new job opportunity. Their potential employer will have to up the ante with even more incentives than before. This type of added wage pressure certainly doesn't help the Federal Reserve's efforts to reduce inflation.

No Incentive to Pay Down a 3% Mortgage

So were you fortunate enough to get a fixed-rate mortgage in the 3% range? Enjoy your home and the gift of that low rate as long as possible. With savings rates and CD rates where they are, there is no incentive to pay down that mortgage early.

For those forced to move, whether that be for a job or otherwise, one option to consider is renting out your current home with its associated low-rate mortgage and finding a rental for a couple years to see where these rates and housing markets settle down.

While another option is to just buy at the new higher rate and hope that rates come back down so you can refinance later – you should not count on that outcome. Rates could stay high for quite some time. You should accept that higher rate only if it is something that you will be able to afford long-term.

This is something you should be especially sensitive to with housing prices continuing to be historically elevated. If you were to buy at this new higher rate and housing prices fell, you could find yourself in a situation where you no longer have enough equity in your home to refinance even if rates did fall.

It's anyone's guess how these factors might intersect and shape the broader economic landscape moving forward. However, one thing is for sure — we are in for an interesting ride.