The $2–4% Mortgage Trap Is Freezing Housing: Defeasance May Be The Way Out

For the past several years, the U.S. housing market has faced an unusual constraint: not a lack of  buyers, but a lack of sellers willing — or able — to move.

Millions of homeowners remain “rate-locked,” holding mortgages originated in 2020–2022 at  interest rates between 2% and 4% (Federal Housing Finance Agency; Freddie Mac Primary  Mortgage Market Survey). While home values have risen, the financial penalty of selling and  repurchasing at today’s 6%–7% rates has discouraged mobility, suppressing inventory and  transaction volume nationwide (National Association of Realtors; HousingWire).

The result is a frozen market dynamic: demand exists, but supply does not respond.

What if the obstacle isn’t demand, affordability, or pricing — but the structure of mortgage payoff itself?

One concept, long established in commercial real estate finance, offers a potential path forward:  defeasance.

Defeasance in plain terms

Defeasance is a financial mechanism that allows a borrower to replace a loan’s payment stream rather than pay off the loan at face value.

Instead of retiring the mortgage entirely, the borrower funds a portfolio of highly secure assets — typically U.S. Treasury securities—that generate sufficient cash flow to make the remaining loan payments (Commercial Mortgage-Backed Securities market practice; Securities Industry and  Financial Markets Association).

Once that substitution is complete, the borrower is released from ongoing responsibility for the loan, while the lender or bondholder continues to receive scheduled payments.

The loan technically remains outstanding.  

The borrower does not.

Defeasance is widely used in commercial real estate to preserve the value of low-rate loans  embedded in mortgage-backed securities (CMBS). The same structural logic could, in theory, be  applied to certain categories of residential mortgages—particularly those already securitized.

Why rate lock is a structural problem

A fixed-rate mortgage at 3% originated several years ago is substantially more valuable than a  new mortgage originated at 6% or higher. Economically, that low-rate loan behaves like a  premium bond.

Yet when a homeowner sells, the mortgage must typically be paid off at full face value — regardless of its favorable rate (Fannie Mae servicing guidelines).

That requirement destroys embedded value.

If, instead, the loan’s economic value—discounted using current interest rates—were substituted for the payoff, the homeowner could unlock equity currently trapped within the mortgage structure itself.

This is the logic behind defeasance.

A simplified illustration

Current home

• Home value: $500,000
• Mortgage balance: $400,000
• Interest rate: 3%
• Monthly payment: ≈ $1,700

Current market

• New mortgage rates: ~6.3% (Freddie Mac PMMS)

At today’s rates, a 3% mortgage with years remaining is not economically worth its $400,000  face value. Its discounted value may be closer to $300,000–$320,000, depending on remaining  term and duration (bond discounting principles; Treasury yield curve).

Traditional sale (No defeasance)

• Sale proceeds: $500,000
• Mortgage payoff: –$400,000
• Equity available: $100,000
• New mortgage required: ~$600,000 at 6.3%
• Monthly payment: ≈ $3,700

Result: significant payment shock and reduced affordability — often enough to prevent the move entirely.

Sale using defeasance logic

• Sale proceeds: $500,000
• Treasury funding for defeasance: –≈$310,000
• Equity available: ≈$190,000
• New mortgage required: ~$510,000 at 6.3%
• Monthly payment: ≈ $3,150

The homeowner does not retain the 3% loan, but the financial penalty of moving is materially reduced.

Key structural distinctions

• No buyer assumption: The buyer originates a new loan; the defeased loan remains isolated.

• No requalification for defeasance: Credit and income underwriting apply only to the new purchase mortgage.

• No change to commissions or transaction flow: Agents, title, and escrow proceed normally.

• No rate manipulation: This is not refinancing or subsidy — it is a payment-stream substitution.

Which loans are most compatible?

From a structural standpoint, defeasance aligns most naturally with:

• Conforming fixed-rate loans
• Fannie Mae and Freddie Mac securitized mortgages
• Loans already embedded in mortgage-backed securities (MBS)

Portfolio loans, jumbo products, and credit-union loans may be feasible on a case-by-case basis,  depending on institutional policy.

Government-insured programs (FHA, VA, USDA) would likely require regulatory action and are  less immediately adaptable (HUD; VA loan program rules).

Why this matters for 2026

Housing recoveries are often framed in terms of interest rates. But mobility — not rates alone — drives transaction volume (Harvard Joint Center for Housing Studies).

If even a modest share of low-rate mortgages becomes defeasible:

• Sellers regain financial flexibility
• Inventory expands without forced price correction
• Buyer demand meets real supply
• Transaction velocity increases

This would not be a rate recovery.  

It would be a mobility recovery.

Final perspective

Defeasance does not lower interest rates.  

It does not bypass underwriting.  

It does not transfer low-rate loans to buyers.

What it does is remove a structural penalty that currently discourages millions of homeowners  from moving at all.

If housing is to normalize in the next cycle, the solution may not come from monetary policy — but from rethinking how legacy mortgages are unwound.

2026 may hinge less on the Fed — and more on financial architecture. 

Tim and Julie Harris are real estate coaches, bestselling authors, and  podcasters. 
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners. To contact the editor responsible for this piece: zeb@hwmedia.com.