Norbert Michel and Jerome Famularo
One of the latest buzz terms in federal housing policy is the “lock-in effect.” It refers to a homeowner being reluctant to sell their home because buying a new home would require taking out a mortgage at a much higher interest rate. In that sense, higher interest rates are “locking” people into their current homes.
The effect is surely real, and it’s even at the center of a public spat within the administration.
Some reports show that more than half of American homeowners have an interest rate below 4 percent as of the second quarter of 2025, approximately 2 percentage points below current rates. Naturally, people who don’t have to move would be reluctant to sell and risk increasing their monthly living costs.
Back in March, the Federal Housing Finance Agency (FHFA) estimated that the lock-in effect had prevented 1.72 million homes from being sold between 2022 and 2024. Then, in June, FHFA Director Bill Pulte called on Fed Chairman Jerome Powell to resign, arguing that the Fed’s refusal to cut interest rates was “a main reason for the Housing Supply Crisis in this Country.”
While politicians seemingly live off promising to fix problems, the administration (and Congress) should tread very lightly on this one.
For starters, the Federal Reserve cannot simply make interest rates, much less mortgage rates, whatever it wants them to be. Aside from the mechanics, when a central bank tries to force market rates below where market forces say they should be (their optimal or “equilibrium” value), it tends to cause inflation. (In some cases, very high inflation.)
Moreover, lower mortgage rates have an ambiguous effect on housing affordability following periods of high rates.
On one hand, if lower rates lessen the lock-in effect, it could lead to an increase in supply. On the other hand, more buyers would be priced into the mortgage market, leading to an increase in demand for housing. If this increased demand exceeds the increased supply, home prices will rise. And because sellers will also mostly be buyers, it’s not clear there would be a net gain—buying a new home may still be too costly, depending on the combination of lower rates and higher prices.
Taking a step back, the lock-in effect is partially caused by unintended consequences of other federal policies, the lessons of which suggest federal policy needs to be more hands-off rather than more involved in trying to fix housing problems. Additionally, these are compelling reasons for the Fed to focus on its dual mandate of stable inflation and maximum employment, rather than targeting housing market outcomes.
For starters, expansionary monetary policy, especially through mortgage-backed securities purchases, is part of what made housing expensive in the first place. More broadly, federal involvement and backing of mortgages and mortgage-backed securities, primarily through the Federal Housing Administration and the government-sponsored enterprises (GSEs), have made the 30-year fixed-rate mortgage (FRM) more widespread than it would be otherwise.
This dominance of the 30-year FRM is problematic for several reasons, including that it makes the United States mortgage market uniquely vulnerable to the lock-in effect. If adjustable-rate mortgages (ARMs) were more common, for instance, there would be less lock-in effect because homeowners would pay the same market rate whether they stay in their current home or sell it to buy a new one. Compared to other countries, the US now has a greater share of FRMs, and the terms tend to be longer (30 years versus 5 or 10 years).
Congress also appears to be on the brink of subsidizing more housing construction, potentially through policies such as those in the ROAD to Housing Act or by expanding the GSEs. However, subsidizing construction, whether through the GSEs, grants, or tax credits, is a poor policy choice. To say nothing of what such policies do to the federal deficit, they distort housing prices and heighten the risk of overbuilding.
If policymakers want a healthier housing market, they should start by abolishing GSE guarantees and allowing more private competition to set loan terms and housing prices. The government-backed fixed-rate mortgage is an outdated artifact that locks families—and the broader economy—into a fragile and inefficient design.
