We just read that the Fed may lower interest rates later this month. We were told recently that the change in the Fed rate may not always have a direct impact on mortgage rates. How are mortgage rates determined?
— Natalie, Grand Junction
A great question, but not necessarily a simple one. As you noted, when the Federal Reserve raises or lowers interest rates, you usually feel it with credit cards, auto loans, at the gas pump, groceries, etc. However, it usually has minimal influence on mortgage interest rates.
While there are many different factors that affect interest rates, the movement of the 10-year Treasury Bond yield is usually the best indicator to determine whether mortgage rates will rise or fall.
While most mortgages are packaged as 30-year loans, the average mortgage is paid off or refinanced within 10 years, so the 10-year Treasury Bond is a great way to gauge the direction of interest rates. These 10-year Treasury Bonds are packaged into mortgage backed securities and compete for the same investors because they are like other financial options such as stocks.
Just like treasuries and bonds, mortgage rates are very vulnerable to jobs reports, consumer price index, gross domestic product, home sales, consumer confidence, world events, etc.
As a rule of thumb, bad economic news typically follows with lower mortgage rates, and good economic news forces interest rates to increase. In general, a growing and healthy economy leads to higher mortgage rates and a slowing economy leads to lower mortgage rates. Also, if the stock market is rising, typically mortgage rates will follow.
Inflation can also impact mortgage rates. When there is little risk of inflation, we usually see mortgage rates fall. If there are concerns with inflation, interest rates may rise to slow down the money supply.
There is often confusion between Bond rates (also known as the bond yield) vs. Bond prices. When bond rates go up, interest rates usually go up. However, Bond prices have an opposite affect with interest rates. When bond purchases increase, typically mortgage rates increase. A better way to follow this as below:
10-year Bond yield up, mortgage rates up.
10-year Bond yield down, mortgage rates down.
Based on the above, you would believe as Bond yields rise that mortgage rates will rise at the same level. Not necessarily. In some cases, mortgage rates could rise or decline depending on other market factors.
One of the reasons why mortgage rates are so low today is because the Fed has scooped up all the mortgage-backed securities in the past. Because of this they can keep mortgage rates low and entice more would-be buyers into the market.
The timing of the Bond prices can also have an impact. You can read that Bond prices have dropped substantially in the morning, but then rise in the afternoon. If this movement does not make it to the capital markets or takes too long mortgage rates may remain unchanged.
Mortgage rates are usually advertised in eighths, such as 4.125 percent. It will either be a whole number such as 4 percent, or 4.125 percent, 4.25 percent, 4.375 percent, etc.
If you see a rate of 3.86 percent advertised, that is usually an APR, which factors in the costs of obtaining a loan. You may see a rate of 3.99 percent to entice you, but again, this is an APR and not the interest rate.
In summary, a good way to predict which way mortgage rates are headed is to look at the 10-year Bond yield. You can find it on stock stickers or in the newspaper. If it's moving higher, mortgage rates probably are too. If it's dropping, mortgage rates may improve over time.
Thanks again for a great question!
Cherry Creek Mortgage