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What Interest Rates Determine Mortgage Rates?

By Bob Redtree

No one may say with complete accuracy what interest rates determine mortgage rates. Nevertheless, trends are clear and leading economists agree that future rates are tied to the U.S. money supply and government set rates.

Interest Rates Determine Mortgage Rates Indirectly

To understand why government interest rates influence mortgage rates, a brief look at financial markets is necessary. In the most basic sense, the U.S. government, through the Federal Reserve System, controls the amount of money in the U.S. economy. The government may increase of decrease the amount of money available by increasing or decreasing interest rates. The two most important interest rates are those charged on the 10 Year Treasury Note and the Federal Reserve Discount Rate.

The U.S. 10 Year Treasury Note

The federal government raises money by borrowing from investors. Investors may be located within the U.S. or globally. The amount of interest paid on 10 year notes reflects world confidence in the ability of the U.S. to repay its loans. Historically, the amount of interest paid by the federal government and the 30 year fixed home loan rate in the U.S. respond to market pressures in roughly the same way. Stated similarly, the margin between these two rates remains similar though market swings.

The Federal Reserve Discount Rate

The U.S. Federal Reserve sets Discount Rates required for banks to borrower money from the government. These interest rates determine mortgage rates indirectly because banks may borrower money from the government to use in daily operations. As part of daily operations, banks may loan money obtained from the government to customers as loans. In this way, the government controls the cost of money banks must pay. In addition, banks always pass higher cost on to customers. Indirectly, the U.S. government controls the amount credit available and the minimum rate of interest available to the American public.

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