Mortgage rates are affected by a lot of things not directly related to the housing market. Intrinsically tied to the inner workings of the banking system, the process by which home loan interest is determined is at once connected to the supply and demand of home buying and simultaneously detached. Like most other aspects of our current financial system, mortgage interest is fairly opaque to the casual observer, and yet it can greatly affect the amount a home owner spends over the course of their loan term. This week, aligning with a strong jobs report and anticipation of a Fed interest rate hike next month, interest rates started creeping towards the 4 percent mark for the first time in a year with an average 0.6 point according to the Washington Post. How does that all work though?
Before getting into a deeper explanation of how mortgage interest is calculated, it’s worth nothing that rates are still nearing a historic low, and slight fluctuations in the current rates likely won’t be substantially affected in the long term by a fed-rate change (and small less-than-1-percent upticks will not cost you all too much over the course of your loan term). There may be short term instability in the stock market and mortgage market alike as the system braces for new rate changes, though.
Mortgage rates are pegged to the 10 year treasury bond yield. Long term treasury bonds like the 10 year are used to assess a common feeling about the strength of the economy in the long term—they are purchased to provide cash to the treasury and paid back with a fixed amount of interest at the end of the bond term (in this case 10 years).
Treasury bonds are considered safe investments during periods of time where long term investments in stocks are seen as unstable choices, and their value in a portfolio indicates how investors feel about the market at large. When 10 year treasury bond yields are low, it’s in part because other investments are seen as better bets thanks to a strong economy. When bond yields go down, mortgage rates go up—and vice versa.
Mortgage rates are set in eighths of a percent. As the 10 year treasury becomes more or less desirable for investors, mortgage interest rates will go up from 3.75 percent to 3.875 percent to 4 percent and upward (or downward!) This is, of course, the base rate a mortgage is calculated on, with differences in credit score, down payment, outstanding debt, income, employment status, and other lending factors influencing the total rate you are assigned at closing.
Traditionally, when the stock market goes up, so do mortgage rates. When the economy is good, as indicated by higher stock returns, people have more money to put into a high, which brings up the demand for homes and, of course, mortgage loans. In natural market conditions, the amount of cold-hard cash a bank has to lend out to borrowers is limited, and higher allows lenders to “be more selective” about who they lend to and offer loans at a higher rate for more profit.
Our current housing situation is unique however. The stock market has hit new record highs consistently for the past year or so, minus a couple notible dips, but thanks to the virtual collapse of the housing economy not even a decade ago, several additional factors go into play when determining mortgage rates:
- Government support. To try and boost the economy, the federal government has taken great strides to offer loan products with federally-backed insurance to try and help people get into new homes. The housing economy and everything that comes with it—equity for borrowers, stability for cities, economic growth for a variety of sectors from construction to furniture making, etc.—relies on people buying homes, and as of yet people have been unable or unwilling to do so.
- Low Fed interest rates. The Federal Reserve started reducing interest rates well before the last economic crisis and subsequent recession made them virtually permanent. In short, fed rates establish the rate at which banks can “buy” money from the treasury. Lower rates mean getting more money is cheaper, which means more-and-cheaper money for lenders to offer to borrowers. This acts as stimulus for lending and is designed to help businesses and consumers get the money they need for growth, major purchases, refinancing, et cetera lined up via loans. More conservative economists fear that with interest rates bottomed out for a long period of time we are flirting with an inflation crisis, where the amount of money in the economy becomes unnatural and drives down the value of each dollar, though the Fed indicates there is yet to be any substantial evidence of this happening.
In short, rates on mortgages will fluctuate slightly from time to time. Right now is still a historically good moment to secure a mortgage loan, and choosing a fixed rate loan at this level can help ensure a sense of housing price stability for years to come.