Why do mortgage rates fluctuate?

Trying to predict the movement of home mortgage rates is tough — Even for seasoned professionals. Changing economic conditions is one of the biggest causes, as is the government’s monetary policy at a any given time. But at the center of it all is one primary driving force: Supply and demand.


Mortgage rates seem to be rising. Why?

Using today’s economy — and the worldwide pandemic as a backdrop — let’s examine mortgage rate fluctuations in their simplest terms.

Interest rates are going up because the economy is starting to have a more positive outlook on the Covid-19 recovery. The pandemic has been the major force keeping mortgage rates low over the past year. The closer we get to widespread vaccination — and the better our economic outlook as a result — the higher rates will go.

The Coronavirus Relief Bill and Interest Rates

The aim of the new coronavirus relief bill — called the “American Rescue Plan” — is to ease the country’s economic burden and spur spending and growth. A stronger economy means investors are willing to take bigger risks with their investments. This usually means moving money out of “safer” mortgage-backed securities (debt investments) and into other “riskier” financial vehicles (equity investments) — Thus pushing mortgage rates up.

Note: When demand for “safer” debt securities (bonds and mortgages) increases, the supply decreases, so prices increase, and the yield decreases. Since the mortgage market is closely tied to bond yields, this drives mortgage rates down.

Mortgage Rates and Treasury Bonds

The 10-Year Treasury Bond price, which is a big indicator of mortgage rates, is inversely related to how the market is doing. As the market continues to do well, the 10-Year Treasury bond value goes down because the Ten-Year Treasury is known as the safest investment.

When the economy nose-dived last year there was a spike in investor interest in the 10-Year Treasury bond. This, combined with the Federal Reserve’s commitment to keep interest rates low, drove down 10-Year Treasury yields and mortgage rates.

As the economy recovers and people regain confidence in other types of investments, the 10-Year Treasury bond yield will increase and mortgage rates will rise once again.

The long version: Of course, it’s a little more complicated than that, but you get the idea. For a more detailed examination of the mortgage market, see below.

5 Factors Affecting Mortgage Rates

While the financial health of borrowers affects the interest rate they will be offered on a loan, economic factors and government monetary policy affect the whole mortgage rate universe.

There are five major factors at play, and all of them reflect the fundamental rules of supply and demand. Some of these elements are complex, but a basic understanding of the underlying concepts will help explain the interest rates you are paying now and what could be coming in the future.

01 Inflation

The upward movement of consumer prices due to inflation is a reflection of the overall economy, and a critical factor for mortgage lenders. Inflation erodes the purchasing power of dollars over time. So, to make a net profit, mortgage lenders have to maintain interest rates at a level that is at least sufficient to overcome this erosion. Consequently, inflation generally leads to higher mortgage rates.

02 The Rate of Economic Growth

Economic growth indicators, such as gross domestic product (GDP) and the employment rate, influence mortgage rates. Economic growth leads to higher wages and greater consumer spending, including consumers seeking mortgage loans for home purchases. That’s good for a country’s economy, but the increase in demand for housing tends to propel mortgage rates higher. The reason: Lenders only have so much capital to lend.

03 Federal Reserve Monetary Policy

The Federal Reserve Bank does not set specific interest rates in the mortgage market. However, its actions in establishing the Federal Funds Rate — and adjusting the money supply upward or downward — have a significant impact on the interest rates available to the borrowing public. In general, increases in the money supply put downward pressure on rates, while tightening the money supply pushes rates upward.

04 The Bond Market

Banks and investment firms market mortgage-backed securities (MBS) as investment products. The yields available from these debt securities must be sufficiently high to attract buyers that might otherwise purchase government bonds and corporate bonds. The money you can earn on these competing investment products affects the yields the MBSs offer.

One frequently used government-bond benchmark to which mortgage lenders often fix their interest rates is the 10-Year Treasury Bond yield. Typically, MBS sellers must offer higher yields because repayment is not 100% guaranteed as it is with government bonds.

05 Housing Market Conditions

Trends and conditions in the housing market also affect mortgage rates. When fewer homes are being built or offered for resale, the decline in home purchasing leads to a decline in the demand for mortgages and pushes interest rates downward.

A recent trend that has also applied downward pressure to rates is an increasing number of consumers opting to rent rather than buy a home. Such changes in the availability of homes and consumer demand affect the levels at which mortgage lenders set loan rates.

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About Kristen Wilson

Kristen Wilson is a licensed loan officer and owner at Network Mortgage in Chico, California. She has been helping clients with mortgage financing for over 20 years.

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