LEILA FADEL, HOST:
The Federal Reserve held interest rates steady this week. It also signaled it could cut rates soon. Turns out the high rates could be creating an unintended consequence for the housing market. Wailin Wong and Darian Woods of our Planet Money podcast The Indicator explain.
WAILIN WONG, BYLINE: We're going to kick things off with a data point from Julia Fonseca. She's an economist at the University of Illinois at Urbana-Champaign. And she says, as of March, around 60% of people with mortgages had rates below 4%.
DARIAN WOODS, BYLINE: Compare that with nearly 7%. That's the current average rate for a 30-year fixed mortgage right now. This difference in mortgage rates has created something called mortgage lock-in.
WONG: This is when a homeowner doesn't want to move because their mortgage rate would nearly double.
JULIA FONSECA: Mortgage lock-in is still very much alive. I hear this from so many people that think that they want to move to a different city or their house is just too small for them, but it's so hard to give up these rates.
WONG: Julia and two fellow academics recently dug into what's happening with mortgage lock-in and the housing market. They knew that lock-in was affecting the demand side of the equation because people with starter homes, for example, were staying put instead of trading up to a bigger home.
WOODS: But that, of course, also affects the supply side because it means there are fewer existing homes going onto the market.
FONSECA: So you're at the same time taking out both supply and demand. So what is actually the net effect on prices?
WOODS: The net effect, it turns out, is that prices have risen.
FONSECA: That is the - let's call it the puzzle that we wanted to address in this new work. And it's really important that we understand what this net effect is, especially at this point, where we - it seems like we have shifted from diagnosing that people are locked in to thinking about what to do about it.
WONG: Remember, higher interest rates are supposed to affect the demand side of the equation. They're supposed to help cool off the economy and bring inflation down. But what Julia says is happening in housing is that the high interest rates are affecting the supply side more. That's leading to higher home prices.
FONSECA: This implies that raising interest rates from low levels to fight inflation will itself create some inflation through housing markets.
WOODS: And there's another wrinkle. Homebuilders can't just build more because their business model means they have to borrow before they build, and higher interest rates are making it way more expensive for them to do that.
WONG: To sum this whole thing up, higher interest rates appear to lead to higher home prices. Now, if you're thinking what a paradox, that's actually how Julia and her co-authors describe the situation in their paper. But she also says, let's not just rip up the Fed's entire inflation-fighting playbook.
FONSECA: Now, I just want to be clear that that doesn't mean that monetary policy is not effective. It also doesn't mean that we're about to enter into a spiral of rate hikes and further inflation and then more rate hikes. It just means that the Fed's job is going to be harder, in all likelihood, than it would be if this lock-in wasn't there.
WOODS: In the meantime, the Fed makes its next interest rate decision in September, and we will see if homeowners start to get unlocked from their mortgages by the end of the year.
WONG: Wailin Wong.
WOODS: Darian Woods, NPR News. Transcript provided by NPR, Copyright NPR.
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