Wednesday, July 26, 2006

Adventures in First-Time Homebuying #2: Why Do Mortgage Rates Go Up and Down?

Author: Nick
Category: Money
Topics: , ,

this house might cost less tomorrow than it does today

If you’ve ever been to a mortgage rate comparison website like, you’ve probably noticed those “overnight averages” charts showing the current interest rates on mortgage and other loan products. You may have also noticed that those rates can and often do change on a daily basis. In recent months, that change has been ever-higher with the occasional temporary retreat.

But have you ever stopped to think what drives mortgage interest rates? Why could the rate for a 30-year fixed conventional loan climb to 6.45% APY when it was 6.40% just yesterday? Is there some guy in a room who decides that it’s time for lenders to raise their mortgage rates? Or is there a mystical force which dictates their direction?

Understanding why mortgage loan rates fluctuate can be difficult, but there are some basic factors that come into play when banks decide their current rate offerings.

  • Bonds. If you’re ever at a party and a hot girl or guy asks you to tell him or her why interest rates rise and fall, just smile, run your fingers through your hair, and say, “Because of bond prices. Now let’s make out.” Sure, it’s a bit more complicated than that, but higher bond prices typically mean lower mortgage rates and vice versa. To make a long story short, when you get a mortgage loan from a bank, the bank will turn that loan into a bond for investors to buy. When the bond market is hot and investors are willing to pay more for those bonds, the banks can afford to drop their rates. But when the bond market fizzles, they’ll need to bump up the rates on your loan (and, thus, on the resulting bonds) in order to attract investors again. And in case that explanation is too long: bond prices go up, mortgage rates go down.
  • Inflation. When inflation is high, you’re going to be paying more money for things. Rampant inflation typically means the economy is growing very quickly, so the Federal Reserve steps in to raise interest rates and stop the economy from growing too quickly. So until inflation and prices get back under control, mortgage rates will typically rise with other interest rates. And when the economy slows, inflation drops and so do mortgage rates.
  • Demand for mortgage loans. If lots of people want to buy homes or refinance, then most of them will need mortgage loans. And when people are climbing hand over fist to get a loan, lenders can get away with jacking up their rates. Similarly, a low demand for mortgages means lenders must cut their rates in order to intice people to apply for them.
  • Housing prices. Higher home prices typically mean that people will need to borrow more to buy them. And if interest rates are too high, they can’t afford to get a loan for those super-expensive houses. Thus, as housing prices climb, interest rates usually come down to compensate.
  • Value of a dollar. If the value of the U.S. dollar (or whatever your country’s currency is) goes up, that’s a good sign that inflation is falling. And as I mentioned earlier, inflation typically takes mortgage rates in the same direction.
  • Many other economic factors, but to lesser degrees. In a way, every transaction involving money anywhere in the country will have some sort of an effect on the economy and a resultant effect on mortgage rates. A single positive earnings report from a big company could push stock markets higher which would temporarily draw investors away from bonds, sending mortgage rates higher. A slew of other factors, such as personal income and spending, housing starts, retail sales, gas prices, and even the political climate can have some sort of an effect on mortgage rates. To put it simply, anything that can affect the economy can also affect mortgage rates.

If you’re in the market for a home, it is to your benefit to pay close attention to these economic factors as you prepare to obtain a mortgage loan. Once you apply and you’re able to lock in your rate, you’ll want to consider what rates might do between then and your closing.

A good one-stop shop for intelligent thoughts on what rates may do in coming weeks is this Daily Mortgage Commentary. It’ll tell you what bond markets are doing and what key economic figures will be released in the next few days that could affect rates, and it will also offer the author’s suggestions as to whether or not you should lock your rate immediately or let it float depending on how far off your closing is.

And remember, even a minor change in mortgage rates could save or cost you thousands of dollars over the life of your loan (or immediately if you’re paying discount points), so do your homework on the markets and economy and try your best to time that rate lock to your advantage.

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