Here’s the key that could unlock the U.S. housing market for buyers and sellers

Here’s the key that could unlock the U.S. housing market for buyers and sellers

Portability would encourage liquidity and inventory back into the housing market.

The White House recently proposed a new tax credit aimed at undoing some of this mortgage lock-in. Under the proposal, sellers of starter homes, defined as homes below the median house price in their county, would receive up to $10,000. It’s unclear how effective this policy would be at loosening the mortgage lock-in, for two key reasons.

First, 80%-90% of sales are existing home sales, and both the buyer and the seller typically have mortgages. Unless they’re looking to become renters, owners of starter homes will have to find another home to buy before they’re able to sell. The seller of this other home might not be eligible for the tax credit, as people typically move from starter homes to homes that are larger and more expensive.

So even if the tax credit gives flexibility to owners of starter homes, they might still not be able to move if the owners of trade-up homes are still locked in. In other words, if only the homeowners in one rung of the housing ladder are locked in, this still has consequences for the other rungs.

A motivated buyer could induce a locked-in seller to sell by offering them more money. If the owner of a starter home is eligible for the tax credit and the owner of the trade-up home isn’t, the two could split the funds through a higher purchase price.

But that leads to the second reason to be skeptical about this policy: The tax credit isn’t that large relative to how much low mortgage rates are worth to borrowers. In our research, we estimate that the average borrower would need $50,000 to compensate them for giving up the rate that they’ve locked in. Freddie Mac also estimated this dollar value and put it at $66,000, similar to our estimate. The maximum tax credit of $10,000 is small by comparison, so it might not be enough to encourage even one homeowner to sell, let alone two.

Yet if a $10,000 tax credit is too small to be effective, a larger subsidy would come with substantial risks: Increased government spending could create inflationary pressure, forcing the Federal Reserve to keep interest rates higher for longer. This would be counterproductive and prolong the effects of the mortgage lock-in.

What else could government policy do? One approach would be to target the challenges that prevent borrowers from holding on to the value of these locked-in rates if they move.

As things stand, borrowers can either stay put and keep their low rates or move and get a new mortgage at current rates. An important reason why there is no middle option is that mortgage borrowers can’t directly renegotiate contract terms with their lenders. Most mortgages are not held by lenders on their books but rather are securitized and sold to mortgage-backed securities investors. So instead of negotiating with lenders directly, borrowers have to negotiate with mortgage servicers, who often lack the incentives to renegotiate.

This is true even when mortgages can be assumed — meaning that new borrowers can buy out existing homeowners and take over the low mortgage rate when buying the house — as is the case for loans backed by the Federal Housing Administration and Department of Veterans Affairs.

For example, the Wall Street Journal recently reported that assumptions rarely happen in practice due to unwilling servicers, as well as high cash requirements. The latter means that even if a homebuyer finds a seller with an assumable mortgage, they can only assume what is left of the existing loan. So, if house prices have increased or the existing loan has been partially repaid, borrowers have to come up with the difference between the current loan balance and the house price in cash, or take out a second lien at a higher rate.

There are solutions that encourage and incentivize renegotiation. One alternative to assuming someone else’s mortgage is to take your own mortgage with you to a new house, a feature that is called portability and is available in the U.K. and Canada, for example. Policymakers should encourage servicers to allow borrowers to port their mortgage when moving in exchange for a fee, which should be both more effective and less inflationary than subsidies.

Porting would be good news for current borrowers who do not want to give up their low rates, although first-time buyers would still feel the pinch from high rates and high house prices. But by making it easier for homeowners to move and sell, portability would encourage liquidity and inventory back into the housing market, a first step toward unlocking it from its current gridlocked state.

Julia Fonseca is an assistant professor of finance at Gies College of Business at the University of Illinois at Urbana-Champaign.

Lu Liu is an assistant professor of finance and real estate at the Wharton School, University of Pennsylvania.

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