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Glossary:
Get help understanding the terms.
Why Do Mortgage Rates Change? |
To understand why mortgage
rates change we must first ask the more general question,
"Why do interest rates changLong-debt instruments used by the
U.S. Government to finance its debt. Treasury bonds
come in 30-year denominations. e?" It is important
to realize that there is not one interest rate, but
many interest rates!
- Prime rate:
The rate offered to a bank's best customers.
- Treasury bill rates:
Treasury bills are short-term debt
instruments used by the U.S. Government to finance
their debt. Commonly called T-bills they come in
denominations of 3 months, 6 months and 1 year.
Each treasury bill has a corresponding interest
rate (i.e. 3-month T-bill rate, 1-year T-bill rate).
- Treasury Notes:
Intermediate-term debt instruments
used by the U.S. Government to finance their debt.
They come in denominations of 2 years, 5 years and
10 years.
- Treasury Bonds:
- Federal Funds Rate:
Rates banks charge each other for
overnight loans.
- Federal Discount Rate:
Rate New York Fed charges to member
banks.
- Libor: : London
Interbank Offered Rates. Average London Eurodollar
rates.
- 6 month CD rate:
The average rate that you get when
you invest in a 6-month CD.
- 11th District Cost
of Funds: Rate determined by
averaging a composite of other rates.
- Fannie Mae-Backed
Security rates: Fannie Mae pools
large quantities of mortgages, creates securities
with them, and sells them as Fannie Mae-backed securities.
The rates on these securities influence mortgage
rates very strongly.
- Ginnie Mae-Backed
Security rates: Ginnie Mae pools
large quantities of mortgages, secures them and
sells them as Ginnie Mae-backed securities. The
rates on these securities influence mortgage rates
on FHA and VA loans.
Interest-rate movements
are based on the simple concept of supply and demand.
If the demand for credit (loans) increases, so do
interest rates. This is because there are more buyers,
so sellers can command a better price, i.e. higher
rates. If the demand for credit reduces, then so do
interest rates. This is because there are more sellers
than buyers, so buyers can command a lower better
price, i.e. lower rates. When the economy is expanding
there is a higher demand for credit, so rates move
higher, whereas when the economy is slowing the demand
for credit decreases and so do interest rates.
This leads to a fundamental
concept:
- Bad news (i.e.
a slowing economy) is good news for interest rates
(i.e. lower rates).
- Good news (i.e.
a growing economy) is bad news for interest rates
(i.e. higher rates).
A major factor driving interest
rates is inflation. Higher inflation is associated
with a growing economy. When the economy grows too
strongly, the Federal Reserve increases interest rates
to slow the economy down and reduce inflation. Inflation
results from prices of goods and services increasing.
When the economy is strong, there is more demand for
goods and services, so the producers of those goods
and services can increase prices. A strong economy
therefore results in higher real-estate prices, higher
rents on apartments and higher mortgage rates.
Mortgage rates tend to move
in the same direction as interest rates. However,
actual mortgage rates are also based on supply and
demand for mortgages. The supply/demand equation for
mortgage rates may be different from the supply/demand
equation for interest rates. This might sometimes
result in mortgage rates moving differently from other
rates. For example, one lender may be forced to close
additional mortgages to meet a commitment they have
made. This results in them offering lower rates even
though interest rates may have moved up!
There is an inverse relationship
between bond prices and bond rates. This can be confusing.
When bond prices move up, interest rates move down
and vice versa. This is because bonds tend to have
a fixed price at maturity––typically $1000.
If the price of the bond is currently at $900 and
there are 10 years left on the bond and if interest
rates start moving higher, the price of the bond starts
dropping. The higher interest rates will cause increased
accumulation of interest over the next 5 years, such
that a lower price (e.g. $880) will result in the
same maturity price, i.e. $1000.
Effect of economic data
on rates
Number of arrows indicates potential
effect on interest rates. 1 arrow=least effect, 5
arrows=max. effect
| Consumer Price Index (CPI)
Rises |
 |
Indicates rising inflation.
|
| Dollar Rises |
 |
Imports cost less; indicates
falling inflation. |
| Durable Goods Orders Increase |
|
Indicates expanding economy |
| Gross National Product Increases |
|
Indicates strong economy |
| Home Sales Increase |
|
Indicates strong economy |
| Housing Starts Rise |
|
Indicates strong economy |
| Industrial Production Rises |
|
Indicates strong economy |
| Business Inventories Rise |
|
Indicates weak economy |
| Leading Indicators (LEI)
Increase |
|
Indicates strong economy |
| Personal Income Rises |
|
Indicates rising inflation |
| Personal Spending Rises |
|
Indicates rising inflation |
| Producer Price Index Rises |
|
Indicates rising inflation |
| Retail Sales Increase |
|
Indicates strong economy |
| Treasury Auction Has High
Demand |
|
High demand leads to lower
rates |
| Unemployment Rises |
|
Indicates weak economy |
|
