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to FAQ's > |
| Why
Do Mortgage Rates Change? |
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| To
understand why mortgage rates change we must first
ask the more general question, "Why do interest
rates change?" It is important to realize that
there is not one interest rate, but many interest
rates! |
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Prime Rate:
The rate offered to a bank's best customers.
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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). |
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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. |
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Treasury Bonds:
Long-debt instruments used by the U.S. Government
to finance its debt. Treasury bonds come in
30-year denominations. |
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Federal Funds Rate:
Rates banks charge each other for overnight
loans. |
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Federal Discount Rate:
Rate New York Fed charges to member banks. |
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Libor: London
Interbank Offered Rates. Average London Eurodollar
rates. |
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6 Month CD Rate:
The average rate that you get when you invest
in a 6-month CD. |
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11th District Cost of
Funds: Rate determined by averaging
a composite of other rates. |
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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. |
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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. |
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| 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. |
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| This
leads to a fundamental concept: |
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Bad News
(i.e. a slowing economy) is good news for interest
rates (i.e. lower rates). |
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Good News (i.e.
a growing economy) is bad news for interest
rates (i.e. higher rates). |
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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.
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