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What Drives Mortgage Rates?

By Kevin Landis

Wondering what drives mortgage rates? Is it banks or really something else? Mortgage rates are actually based on the following three things.

Three factors drive mortgage rates the most: yield on 10-year Treasury, risk premium demanded by investors in the mortgage backed securities market, mortgage supply from borrowers as originated by banks.

10-Year Treasury and Its Risk-Free Rate

Change in Yield on 10-year Treasury is thought to be the best indicator for mortgage rates. Most mortgages are paid off or refinanced around the 10th year and that makes the risk-free 10-year Treasury a comparable benchmark. Inflation as a factor affecting all interest rates is always adjusted into the Treasury yield in its pricing and thus mortgage rates take into account any inflation factor as well. Mortgage rates move in the same direction as yield on the 10-year Treasury though they may not be by the same percentage points every time.

Investors’ Risk Premium on Mortgage Rates

On top of the risk-free rate of the 10-year Treasury yield, investors buying mortgage-backed-securities, the ultimate credit providers to mortgage borrowers, normally add 170 basic points(100 points equals to 1%) to reflect borrowers’ default risk and earlier re-payment risk. When yields on mortgage-backed securities as traded in the market with and among investors are reported back to banks, they are quoted in mortgage applications to potential borrowers, although there may be time delays between the two fronts sometimes.

Supply/Demand Pressure on Mortgage Rates

In good economic times, mortgage supply from mortgage borrowers likely go up and demand for mortgage-backed securities from investors probably come down because of other competing investment opportunities in a good economy. Whenever supply overwhelms demand, the price is forced to be lower and in this case of mortgage-backed securities, the yield or mortgage rate has to be higher to adjust to the imbalance, as yield and price move in opposite directions. By the same token, mortgage rates tend to be lower in bad economic times as supply and demand are in a reversed imbalance. Banks serving as the intermediary between borrowers and investors must set a mortgage rate, but they are not the driver of mortgage rates.

Related posts:

1. Why Is The FED Having Less Influence Over Mortgage Interest Rates?
2. What Causes Mortgage Rates To Change?
3. Are We In An Economy Where Low Mortgage Rates Don’t Matter?
4. Who Affects Mortgage Interest Rates?
5. How will Mortgage Rates be Affected Once the Fed Pulls Back?