Frequently Asked Questions (FAQ)
Why Do Mortgage Rates Change?
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!
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: Long-debt instruments used by the U.S. Government
to finance its debt. Treasury bonds come in 30-year denominations.
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
Economic Event Effect on
Interest Rates Significance of event
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.
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