Anyone who is looking for a mortgage to buy a new house or refinance an existing mortgage is very aware that interest rates on mortgages rise and fall quickly — sometimes several times a day. But few people who are not intimately involved in the housing market understand exactly what it is that moves the mortgage rates. There’s a very good reason for that — mortgage rates rise and fall based on an incredibly complex series of relationships between a large number of factors. Those factors include the market, the Fed, the interest rates charged by banks to lend money to each other — even how willing Mr. and Mrs. John Q. Public are to spend their money.
There have been entire books written about how mortgage rates are decided, so a comprehensive explanation is far outside the scope of a short piece of writing, but this article will attempt to give at least a broad overview of the basics.
A Simple Explanation of Mortgage Investments
Before you can understand why mortgage rates rise and fall, you have to understand the mortgage market and how mortgages are investments. If you’re a home buyer, you’re not looking at your mortgage as an investment, but the person who is funding the transaction (the one putting up the money to lend to you) is seeing it as exactly that. In very simple terms with very simple interest, if a lender gives you $100,000 at 6 percent annual interest, the lender makes $6,000 a year on that investment. That makes your mortgage a valuable investment.
As long as the lender is the only one who wants that investment — or the only one willing to lend you the money — he or she can pretty much name the interest rate. However, if there are several other investors who want your mortgage, that interest rate will go down as they compete to get your business. If that interest rate goes too low, however, the investors will turn to other investments that pay a higher yield. If, for example, you come back to the lender and say that another company will lend you the money at 4 percent interest, and the lender knows that he or she can make $4,500 a year investing that $100,000 in a stock, he or she would be foolish to offer you the mortgage at 3.5 percent interest.
Now imagine the opposite situation. A lender has $100,000 to lend, and three home buyers who want to borrow it. The more home buyers there are, the more likely it is that the lender can get a higher interest rate — and a higher yield for the money. More investors equal lower interest rates. More home buyers equal higher interest rates. However, the reverse is also true. The lower the interest rates drop, the fewer people will be willing to lend money. The higher the interest rates rise, the fewer people will be willing to pay the interest rates and borrow the money.
As you can see from even that simple explanation, there are several factors that affect the mortgage interest rate. They include:
- Amount of yield expected by investors
- Amount of interest that home buyers are willing to pay
- Number of home buyers in the market
- Number of investors in the market
However, even those few factors are affected by other elements that step outside the housing market. The expectations of investors, for instance, can be affected by the availability of other investments with higher yields. If an investor can make more money investing in pork bellies, there is less money available in the mortgage market and interest rates will rise.
What are Interest Rates Based on?
Of course, banks and lenders don’t sit down and do all that math themselves. Instead, mortgage rates are usually pegged to some specific other investment rate. One popular index is the interest rate on U.S. Treasury bonds. The mortgage interest rate won’t be the same interest rate as that for, say, a 10 year Treasury bond. Instead, it will be “pegged” to that rate, removed by a few percentage points. Generally, since Treasury bonds are guaranteed to be repaid and mortgages are not, the interest rates on mortgages will be higher to account for the higher risk.
While there is a relationship between mortgage interest rates and other market rates, it isn’t a one-for-one lockstep rate. If the Treasury rate rises 1.5 percent, there’s a chance that mortgage rates will rise — but the rise won’t be the exact same.
In general, it’s difficult to predict exactly what mortgage interest rates will do. The best option for tracking mortgage interest rates is to regularly check an online mortgage rate calculator for your area to find the best mortgage interest rates in your desired location.