Understanding Mortgage Rates: What Drives Changes?

Mortgage rates are a critical factor in the home buying process, influencing how much you will ultimately pay for your home over the term of your loan. Given their impact, it’s crucial for potential homeowners and those looking to refinance to understand what drives changes in mortgage rates. This understanding can help you time your mortgage application to secure the best possible rate, potentially saving you thousands of dollars over the life of your loan.

The Basics of Mortgage Rates

Mortgage rates refer to the interest charged on a mortgage loan, expressed as a percentage of the loan amount. These rates can either be fixed, meaning they stay the same for the entire term of the mortgage, or variable, meaning they fluctuate with a benchmark interest rate.

Key Factors Influencing Mortgage Rates

1. Federal Reserve Policies
   • The Federal Reserve (often referred to as the Fed) doesn’t directly set mortgage rates, but its policies influence them. When the Fed adjusts its benchmark interest rate, known as the federal funds rate, it affects short-term and variable interest rates. Although mortgage rates are more closely tied to long-term bond yields, Fed policies can still make an indirect impact.
2. The Bond Market
   • Typically, mortgage rates follow the yields on U.S. Treasury notes, especially the 10-year Treasury bond. Lenders use these yields as a benchmark to set their own rates for fixed-rate mortgages. When investors demand higher yields on government bonds, mortgage rates generally rise. Conversely, when bond yields fall, mortgage rates tend to drop.
3. Economic Conditions
   • Broader economic conditions significantly impact mortgage rates. During periods of strong economic growth, inflation usually increases, which can lead to higher mortgage rates as lenders need to compensate for decreased purchasing power. On the other hand, during recessions, rates tend to fall as the Fed cuts rates to stimulate economic activity.
4. Inflation
   • As noted, inflation erodes the purchasing power of money, which is a critical concern for lenders. If inflation is expected to increase, lenders will hike their rates to ensure the return on the loans they grant retains its value in real terms over time.
5. Housing Market Conditions
   • The supply and demand dynamics in the housing market can also influence mortgage rates. If the demand for homes increases, it often leads to higher mortgage rates as lenders take advantage of the increased demand. Conversely, in a weaker housing market, mortgage rates may be lowered to encourage borrowing.
6. Credit Score of the Borrower
   • While this is more about the rate an individual borrower will receive rather than general market mortgage rates, it’s important to note that your credit score significantly impacts the rate you are offered. Higher credit scores indicate lower risk to lenders, often resulting in lower interest rates being offered to these borrowers.

How Can You Predict Changes in Mortgage Rates?

While it’s impossible to predict future mortgage rates with complete accuracy, you can get a sense of where they might be heading by paying attention to the following indicators:

• Federal Reserve Announcements: Keep an eye on the Fed’s policy meetings and announcements. Statements on interest rates or economic outlook can provide hints about future mortgage rates.
• Economic Reports: Economic indicators such as employment reports, GDP growth figures, and inflation reports can influence mortgage rates. Strong economic data may push rates higher, whereas weaker data might pull them lower.
• Global Events: Significant political or economic events around the world (like Brexit or international trade agreements) can also influence U.S. bond markets and mortgage rates.

Conclusion

Understanding what affects mortgage rates can empower you as a homebuyer or homeowner looking to refinance. By keeping informed about economic conditions, Federal Reserve policies, and the bond market, you can make more educated decisions about when to lock in your mortgage rate. Timing your loan application during periods when rates are favorable can lead to substantial savings over the life of your mortgage. Always consider consulting with a financial advisor or mortgage broker to get tailored advice that considers your personal financial situation and the current state of the mortgage market.