What determines mortgage rates?
Many consumers are misinformed about the different factors in the economy that impact mortgage rates. A common misconception among borrowers and also some members of the media is that the Federal Funds Rate set by the Federal Reserve is tied to mortgage rates. When the Fed cuts the Fed Funds Rate and mortgage rates don't go down accordingly many people are left scratching their heads wondering why.
The reason for this is that mortgage rates are determined by Mortgage Backed Securities (MBS) and the current coupon they are trading at. MBS are traded every business day just like stocks and other bonds. As investor demand for MBS increases, the price of MBS goes up and the yield goes down resulting in lower mortgage rates.
A simple way to think about mortgage rates is anything that increases investor demand to buy mortgages results in lower mortgage rates. For example when an investor pulls money out of stocks they usually turn to safer fixed income investments to put their money and MBS is one option they have. So when stocks decline that is one possible reason demand for MBS could increase. Another factor that can help investor demand for mortgages is low inflation. MBS and other bonds are fixed income investments so inflation diminishes the returns on that type of investment. If inflation is low then the fixed investments remain attractive. On the other side, if inflation is high then investments like MBS are less attractive and demand decreases causing mortgage interest rates to increase.
The reason that mortgage rates often increase when the Fed lowers rates is because the lower Fed rate is a stimulus for the economy and often leads to higher inflation in the future. This is bad for mortgage bonds which is why mortgage rates usually increase when the Fed cuts their rate.
Another misconception some people have is that mortgage rates are based on the US 10 year Treasury Bond. Often times the MBS market moves within a certain spread compared to the 10yr but at times there is a large disconnect between the two. This is the problem we are currently experiencing that is keeping mortgage rates higher than they could be given more traditional spreads. There are days where the yield on the 10yr will drop while the yield for MBS will increase when normally they would move in a similar path.
Daily trading prices and yields for Mortgage Backed Securities are not as readily available as information on stocks markets and government bonds. At HomeQuest Mortgage we subscribe to a service that gives us access to track the daily trading yields of MBS. This allows us to give our borrowers the most up to the minute advice on whether to lock or float their interest rate depending on current market conditions.