Job Market Paper
When interest rates rise, fixed-rate mortgages generate a financial incentive for owners to keep their homes, creating “rate lock”. Does rate lock dampen the negative impact of rising interest rates on house prices? To estimate rate lock’s causal effect on market-level house prices, we instrument for the rate lock incentive in the outstanding local mortgage stock using unexpected family size shocks that induce moves at times with different mortgage rates. We find that when interest rates increased over 2021-23, a one standard deviation increase in the rate lock incentive, corresponding to a 0.3pp lower average outstanding mortgage rate, caused 2.6pp higher nominal house price growth. To understand the mechanism, we compare moves of owners who purchase homes just before and just after sharp mortgage rate increases. A 1pp lower outstanding mortgage rate reduces moves from owning to renting by 33%, a force increasing the price-to-rent ratio, and reduces overall moves by 42%. Using these estimated effects on mobility, we calibrate a dynamic structural model to quantify how much rate lock offsets the negative aggregate price effects of a higher cost of capital. Model simulations indicate that the 2021-23 tightening would have reduced the price-to-rent ratio by 9.1% with adjustable-rate mortgages, and hence no rate lock, versus only 3.5% with fixed-rate mortgages. Rate lock thus dampens, but does not fully offset, negative price effects of higher interest rates.