One of the questions I am most frequently asked is “Where are rates headed?” It’s an important question, as slight differences in your mortgage interest rate can make a difference of thousands of dollars over 15-30 years. But while I appreciate the confidence of my clients in my swami-esque wisdom, predicting interest rates is…pretty hard. It’s best to have reasonable knowledge of what makes mortgage rates change, so that you can take advantage of low rates when they do occur.
The Short-ish Answer
The simplest- and most accurate (in the long term)- predictor of interest rates is the economy. When the economy is good, rates tend to be higher and when the economy is not as good, rates are lower. Likewise, when the economy is improving, rates will rise (and fall when the economy is deteriorating). Interest rates are simply an indicator of the demand for borrowed money and when more people want to borrow money (which normally happens in an improving economy), lenders can charge more interest for that borrowed money.
The Long-ish Answer
While the Short-ish Answer explains long-term fluctuations in interest rates, it doesn’t address the short-term fluctuations.
For this purpose we need a basic understanding of bonds. A bond is essentially a loan to a company/entity/person. If I “buy a bond”, I loan the seller of the bond money in return for interest. Bonds have terms and rates (a 5-yr bond at 4% will return 4% per year and pay back completely in 5 years) and the amount that I pay for that bond upfront (or loan the bond issuer) is the price. The return that I get (the interest) on the price I pay for that point is called the yield. The lower the price in relation to the interest I will earn, the higher the yield (and the less interest I earn in relation to the price I pay, the lower the yield).
Bonds are considered safer investments than stocks (though they normally don’t provide as much return). When stocks are doing poorly (as often happens in a declining economy), investors tend to buy bonds instead. The rules of supply and demand go to work and since a lot of people want to buy bonds, the bond sellers can charge a higher price- which lowers the yield. This yield is tracked and is the basis for a lot of different interest rates.
While the average term of a mortgage is 30 years, many mortgages are either paid off or refinanced within 10 years, so the movement of the 10-year Treasury Bond yield is taken into consideration when determining mortgage rates. When the 10-yr Bond yield goes up (because the economy is improving, investors are buying stocks, and bond sellers have to reduce their prices or increase their interest rates to attract buyers), mortgage rates go up. Conversely, when 10-year Bond yields go down, mortgage rates go down.
But Doesn’t the Fed Control Interest Rates?
The Fed does not control mortgage interest rates. However, actions of the Fed can and do have an effect on mortgage rates. The Fed tries to keep the nation’s economy steadily progressing by buying and selling bonds and raising/lowering the what we call the Fed rate, which is the rate at which large institutions can borrower money from the Fed (through bonds). The Fed increases the Fed rate if they feel the economy is getting too heated (to control for inflation) and decreases the Fed rate if they feel the economy needs a boost (to encourage borrowing/business investment). The Fed’s actions do not directly affect the 10-yr Bond or other important indicators, but people do pay attention to the Fed’s actions and they are seen by many as an indication of the state of the economy or where the economy is heading. In this age of instant information, the Fed’s actions often result in quick and significant changes in mortgage interest rates, although the Fed does not intend to directly influence mortgage interest rates.
Other Factors
In addition to considering the yield of a 10-year bond (and Fed actions to an extent), it’s important to know that almost everything else that affects economic outlook also affects mortgage rates. Employment rates, consumer confidence, Gross Domestic Product, home sale rates, etc., can and do change the going mortgage rate.
Sometimes, when there is a high demand for mortgage loans (in strong housing markets), it gets harder to find investors to back and service all of the loans. Originators make their money by selling their loans to investors, so sometimes rates will be raised in order to slow the number of people trying to take out a loan. Conversely, rates might be reduced (by investors) to stimulate mortgage and housing markets.
Practical Applications of this Knowledge
So, how do you time things just right so that you get the best mortgage rate available in a given month? You can’t. If I had figured out how to do that, I wouldn’t be writing my own blog posts! Billions of dollars are spent each year trying to predict the market, with minimal benefit. The best thing to do is to watch long-term trends and outlooks. The economy has been improving for a while and it will likely continue to improve, so where are rates headed? Up. They might fluctuate day-to-day, but in the long run, they will increase until the economy turns south.
The last—and most important—thing to remember is that your personal financial circumstances also make a huge impact on the mortgage rates available to you. If you are a risky borrower—for example, if you have poor credit or no money down—your rate will likely be higher so that the lender can protect their investment.
Your best course of action, if you’re considering a loan, is to make sure you’re an attractive borrower (which I will touch on in another post), watch the economy and take advantage of rates while they’re still low, and use a mortgage company that will work hard to get you the best rate available for you: like Evergreen Mortgage.
