I remain convinced that the main reason why we won’t see massive inflation in reaction to the monetary easing in this crisis is that banks are unwilling to lend in a low interest rate environment. I have written about some empirical evidence here.
However, while the typical lending channels may be clogged up in a low interest world, it could be that one channel remains open: mortgage lending. Theoretically, it is possible for households to take advantage of lower rates by refinancing their mortgages and increasing the size of their mortgage while keeping monthly payments constant (a cash-out refinancing) or they can just refinance the mortgage to get a lower monthly payment (a rate refinance).
Once refinanced, households have more cash at hand and can thus consume more, creating additional inflation pressures – at least in theory.
Gene Amromin, Neil Bhutta, and Benjamin Keys have compiled some interesting statistics on mortgage refinancing activities in the United States. For example, the chart below shows the refinancing activities in the US mortgage market. During the housing boom of the early 2000s tapping into your home equity was a popular game to get some extra cash. Cash-out refinancing has never recovered after the housing bust but rate refinancing experienced another boom in 2010 to 2012 as interest rates declined and mortgages became significantly cheaper.
Refinancing activities in US mortgage market
Source: Amromin et al. (2020).
The decline in mortgage rates in the United States is clearly visible in the chart below. Between late 2009 and late 2012 30-year mortgage rates declined by almost two percentage points. No wonder households with a good credit rating tried to refinance their mortgages to take advantage of lower rates.
Mortgage rates in the US and UK
Source: Bloomberg, Liberum.
Looking at the most recent trends in mortgage rates we do see a similar-sized decline in US mortgage rates since 2018. So, are we going to see another mortgage refinancing boom in the US that will trigger higher consumption?
I doubt it. The reason why I doubt it is that the starting point for many homeowners today is very different from ten years ago. The chart below shows the distribution of mortgage rates for outstanding mortgages over time. In 2012, after the last refinancing boom, about half of all homeowners still paid mortgage rates of 5% or more. In 2018, just before mortgage rates started to drop again, the majority of homeowners already paid rates of 3% to 3.5%. And there aren’t that many homeowners with mortgage rates of 5% or more left.
Yes, you could refinance your mortgage and get a rate of c. 3% at the moment, but for most homeowners in the United States that is hardly a significant improvement. And remember that refinancing your mortgage incurs fees. That means that most of the time, a refinancing of a mortgage only is worth the effort if you can save a substantial amount of your monthly mortgage payment. Reducing your mortgage rate from 3.5% or 4% to 3% is certainly nowhere near as appealing as reducing it from 6% to 4% as you could have done in 2012.
In other words, lower mortgage rates will be an incentive for some homeowners to refinance their mortgage, but I don’t expect a mortgage boom and I certainly don’t expect a significant boost to consumption and inflation from this channel.
Distribution of outstanding mortgage rates
Source: Amromin et al. (2020)