The typical home loan in America is a gift. It's also a trap.
Most US homeowners have loans that guarantee they'll pay the same amount each month for decades, regardless of inflation or the shifting winds of the economy. These are called 30-year fixed-rate mortgages, and they offer rare bright spots of certainty in the housing market's endless cycle of booms and busts. Lock in a favorable rate, and you're on the steady track to prosperity.
But these sweetheart deals can cause big problems. When mortgage rates shoot up, as they did over the past two years, many would-be sellers decide they don't want to move after all. Sure, a new home could be nice, but trading up would mean parting ways with a cheap mortgage rate. What may have been a welcome change suddenly sounds like a painful, expensive divorce. So they sit tight. A gummed-up housing market is good for nobody: First-time buyers can't find enough homes for sale, and wannabe sellers remain trapped in places that are either too big or too small. This is called the lock-in effect — and it could linger for decades.
"Unfortunately, we've known about the lock-in possibility for many, many years," John Campbell, a Harvard economist, told me. "But we didn't fix the roof while the sun was shining, and now it's raining."
Economists and housing wonks are obsessed with this uniquely American problem. One estimate suggests the lock-in effect prevented more than 1 million people from selling their homes in the span of just a year and a half, a steep toll considering about 5 million homes exchange hands in a typical year. I used to think of these golden handcuffs as an inevitable side effect of the magical 30-year fixed mortgage. But it doesn't have to be this way. The answer to our problems may lie thousands of miles away … in Denmark.
Many homeowners in Denmark, like their American counterparts, enjoy 30-year fixed-rate mortgages. But thanks to a quirk of their housing-finance system, Danish sellers are able to earn a profit when they trade in their low mortgage rates for more-expensive ones, making it easier to move even when rates rise. As a result, the Danes dodge the lock-in effect entirely.
Implementing a similar system in the US would require an overhaul of our mortgage market and would almost surely be met with lots of foot-dragging from regulators and investors. But the alternative — twiddling our thumbs until the next Housing Ice Age — is far worse. Maybe it's time we take a page out of the Scandinavian playbook instead.
Buyers may remember the pandemic-era housing market for its worst qualities: the bidding wars, the late-night doomscrolling on Zillow, the smug investors bragging on TikTok about how many homes they flipped that month. But regular house hunters scored a pretty good deal in at least one respect: Home loans were outrageously cheap. The typical 30-year mortgage rate plummeted to a record low of about 2.65% in late 2020, according to Freddie Mac. Existing homeowners pounced on the opportunity, too, refinancing their mortgages to get new loans with cheaper rates.
As the Federal Reserve began pushing up borrowing rates in the spring of 2022, hoping to reel in rising inflation, mortgage rates went vertical. Rates doubled in less than a year, with the typical rate nearing 8% in October, a 20-year high. Rates have fallen a little since then, but they're still hovering at about 7%. In the grand scheme of things, that's not crazy at all — buyers who bought homes in the early '80s may recall rates closer to 18%. But for buyers and homeowners who got used to rock-bottom rates in the decade after the financial crisis, the reversal was chilling.
A recent working paper from the Federal Housing Finance Agency estimated that the lock-in effect prevented 1.3 million home sales between mid-2022 and the end of 2023. The vast majority of US mortgages have fixed rates — about 96% at the end of last year — and 63% of those had rates below 4%. The agency estimated that with rates at about 7%, these homeowners would pay roughly $500 more each month on their mortgage if they got a new rate on a house of the same value. If you do a little convoluted math to figure out what all those extra payments would be worth in today's dollars, it'd be like taking $60,000 and lighting it on fire, according to the FHFA's calculations.
Even if rates were to fall to 6% or 5.5%, "you're still going to have people who are not going to move, who are not going to give up their house forever, basically," Will Doerner, an economist at the FHFA and a coauthor of the paper, told me. "It's going to take a heck of a change for them to ever want to get rid of those mortgages."
OK, so maybe you're not shedding any tears on behalf of these homeowners sitting on piles of equity and their sweet, sweet mortgage rates. But the lock-in effect warps the entire housing market. Fewer sellers means buyers compete for a smaller pool of available homes, driving up prices and locking out many first-time and low-income buyers. It means many people who want to move — to find a better job, start a family, upgrade, or downsize — don't have that option. A once theoretical hang-up has turned into a massive headache.
Unfortunately, we've known about the lock-in possibility for many, many years. But we didn't fix the roof while the sun was shining, and now it's raining.
These golden shackles are a problem only in America. In Canada, the UK, or Australia, you can get a loan with a fixed rate for maybe five or 10 years, but then it'll adjust periodically to match the swings in the economy. Homeowners in these countries may not have to grapple with the same lock-in effect, but their monthly budgets get hit when borrowing rates go up.
Then there's Denmark, the only other country in which similar 30-year fixed-rate mortgages are widely available — more than half of Danish borrowers have them. And just as they have in the US, rates for those mortgages have risen sharply. Over the course of 2022, the typical rate for a 30-year mortgage in Denmark climbed by roughly 4 percentage points, the largest jump in 40 years. But Denmark's housing-finance system is almost perfectly designed to shield it from the lock-in effect. And it's all thanks to a bit of financial magic known as covered bonds.
I really wish these things had sexier names, because if 30-year-fixed mortgages are gifts to homeowners, then covered bonds are straight-up miracles. Here's how they work: When a bank gives a mortgage to a homebuyer, it creates matching bonds that it sells to investors. The bank gets cash to extend more loans, and the owners of these covered bonds get a steady stream of payments from the people paying back the mortgage. The value of the bonds, and therefore the value of the underlying mortgages, rises and falls like any other asset traded in the financial markets. When borrowing rates for new mortgages go up, the value of bonds tied to older, cheaper mortgages goes down — in the eyes of investors hungry for higher returns, a loan that pays 7% interest is worth more than one that pays only 3%. This does not mean, however, that the value of the actual house has dropped; even if bond investors aren't as keen on the underlying loan, there may be plenty of regular buyers who still want the house. So far, this system of pooling together mortgage bonds and selling them to investors is pretty close to the American way of doing things. The real magic happens later, when it comes time to settle up.
When US homeowners pay off their mortgages, they have only one option: pony up the amount left on the loan. But when Danish homeowners pay off their mortgages, they have two choices: pay back the balance of their home loan, same as Americans, or pay the market value, which is the amount their covered bonds would trade for on the open market. If interest rates go up and the value of those bonds falls below the amount remaining on their loan, it becomes cheaper for the Danes to pay off their mortgages.
Here's an example in dollars: Let's say the face value of a mortgage, or the amount a homeowner would have to pay to get rid of it, is $500,000. But then interest rates rise by, say, 4 percentage points. In the US, this turn of events would trap many homeowners in their house; they would have to not only pay back the $500,000 but get a new mortgage with higher interest payments. In the Danish model, the same situation could work out in the homeowner's favor. That's because as general interest rates rise, the market value of the covered bonds, and therefore the underlying mortgage, drops. So instead of having to pay back the entire mortgage, the Danish homeowner could go out and buy back matching bonds for, let's say, $400,000. If they sell their home for $700,000, they get to pocket $300,000 instead of only $200,000 (not including pesky fees, of course).
This lucky Danish homeowner may have to turn around and buy another home with a higher rate, sure, but the profit from paying back their loan at its market value gives them a buffer to do so. Danes don't even have to sell their house to unlock their savings — they can choose to refinance. In that case, they would have to borrow only $400,000 instead of $500,000 to pay off the original loan. Again, the interest rate on the new loan is higher, but the principal balance is lower, so the monthly payments would stay roughly the same.
In essence, Danes reap all the rewards when rates go up and face none of the downside risks when rates fall. Their mortgages are also assumable, which means sellers can hand off their loans to qualifying buyers. As a result, Danish homeowners don't cling to their low-rate mortgages the way Americans do. Their setup "eliminates the lock-in effect," Campbell told me.
While the Danish system may seem complex, it's not totally absurd to think we could adopt something similar here. It would take a lot of work: overhauls of Fannie Mae and Freddie Mac, a massive education campaign for consumers, and maybe even an act of Congress. It's not as if you can just wave a wand and grant homeowners permission to start paying back their mortgages at market value — the existing contracts explicitly lay out the repayment terms, and mortgage bonds are bundled together here in a way that makes it impossible to pluck one out of the pool as they do in Denmark.
Anything that gives consumers protection from rising interest rates would come at a cost, too. Banks would demand borrowers pay higher interest rates from the start of their loans, Jesper Berg, the former director of the Danish Financial Supervisory Authority, told me. Danish mortgage rules are stricter in other ways that favor the lender: Borrowers are required to put down 20% of the home's price, and foreclosures are speedy thanks to a more creditor-friendly legal system.
I just think it's a more efficient system that will prevent problems for both individual borrowers who get stuck and for the economy as a whole.
But there's still a way forward. There is some precedent for sweeping changes to mortgages — think back to the financial crisis in the mid-2000s, when the government instituted massive programs like HARP to help underwater homeowners refinance their mortgages. It required investor buy-in and lots of rule changes to rework existing loan terms, but it showed a willingness to adapt in dire circumstances.
Campbell isn't some starry-eyed dreamer who thinks we can snuff out these issues overnight. Embracing the Danish approach to mortgages would require much bigger changes than the recession-era programs, and mortgage reform tends to move at a glacial pace. But the lock-in effect is the kind of intractable problem that demands big solutions. The Danish model combines the best of the US mortgage market — the stability, the cost savings for homeowners — with consumer protections to ensure they're not held hostage by those same perks. The Danes can move around during times when it would make little financial sense for US borrowers to do so. That's not just good for buyers or sellers or mortgage loan officers — it's good for everyone.
"I just think it's a more efficient system that will prevent problems for both individual borrowers who get stuck," Campbell told me, "and for the economy as a whole, which suffers when people get locked in."
James Rodriguez is a senior reporter on Business Insider's Discourse team.