The economic factors and conditions that cause mortgage rates to rise and fall are somewhat complicated. Many consumers think that the government and/or the Federal Reserve actually control and set mortgage rates. Although the Fed does not directly control mortgage rates, many of their policies, including setting the Federal Funds target rate, have an impact on mortgage rates in indirect ways. Predicting mortgage rates is always more of an educated guess than an exact science. Having said that, there are some factors that almost always have a predictable effect on mortgage rates. These effects are often magnified when combined with other factors in the economy, and the outcome is sometimes as surprising as in any other market, such as stocks, bonds or even commodities prices like the price of a barrel of oil.
While many individual factors may have an influence on mortgage rates, here are some common factors that have a somewhat predictable effect on the direction of rates:
INFLATION
When economic indicators point towards rising inflation, mortgage rates will typically rise. The reason is simple. Investors who purchase mortgage-backed securities will demand a higher rate of return if they suspect their money will be losing value due to inflation. To explain this on a micro level, if you perceive the cost of living to be higher, you will more than likely look for a bank that will pay a higher rate of interest so that your money does not lose value. Every investor will try to protect their money against inflation by seeking a higher rate of return, which translates into higher rates for mortgages.
STOCK AND BOND PRICES
There are two major vehicles of investment: Stocks and Bonds. Stocks are generally considered higher risk, but they carry a higher possibility of larger return on investment. Bonds on the other hand are considered a safer investment but typically offer lower rates of return than well performing stocks. And since mortgage backed securities function in much the same way as bonds and investors view them as a safer investment than stocks, they tend to follow the bond market. In times of economic prosperity, most investors are bullish on the stock market and bearish on bonds since stocks do better in good times. But when that changes, investors will often sell stocks and park their money in bonds to "wait on the sidelines", so to speak, until the economy improves. Whenever there is increased demand for an investment, the price increases. Notice that on many days, bond prices will INCREASE when the stock market declines. And when the price of mortgage-backed bonds INCREASES because of higher demand for those investments, the interest rates on home loans tends to DECREASE.
So remember this GENERAL rule:
When stocks sell off (decline), lots of that money goes into bonds, which tends to LOWER mortgage rates.
When stocks prices rise, investors sell bonds to buy more stocks, which tends to RAISE mortgage rates.
There are exceptions to this rule. If stocks sell off because of inflation fears, mortgage rates may not follow suit since investors may choose to park their money in bonds that offer higher returns than mortgages to counter the effects of inflation on their investments. There are many types of bonds besides mortgage-backed bonds, and the supply and demand fundamentals of this entire market effect mortgage rates as well. So don't assume that mortgage rates will always move inversely with the stock market. In my experience, mortgage rates tend to move inversely with the stock market about 70% of the time.
CONFIDENCE IN THE SYSTEM
This was hardly a factor up until the sub-prime mortgage crisis began, which spilled over to Fannie Mae and Freddie Mac. Since the risk on many of the mortgages that were originated over the last few years was misrepresented to investors because of a rating system with little oversight, a lack of confidence in the system developed, which has led to mortgage rates being more volatile recently. Although the government bailout of Fannie and Freddie helped to stabilize this, non-government and GSE backed mortgage rates have surged significantly, and many non-prime programs are simply not avilable anymore because there is no investor demand for those products. This explains why hard money loans have made such a dramatic comeback over the last year. Investors still have a demand for non-traditional mortgage products (such as no income verification loans and investor rehab loans), but they no longer trust Wall Street to accurately predict the risk of these investments so they are choosing to evaluste the risk of each loan on an individual basis. And because of this, the rates on these higher risk mortgages have shot through the roof.
A FEW IMPORTANT THINGS TO REMEMBER:
- Mortgage rates can change daily, and can even change several times within a day if the market is volatile. It's always a good idea to get firm mortgage quotes within an hour of each other so you know you're comparing current market quotes from different lenders.
- No lender can give an accurate rate quote without pulling a three bureau credit report and completing a pre-approval inverview. Other risk factors, such as debt-to-income ratio, loan amount, property type, credit score and down payment can affect the final rate, so be careful about lenders that quote rates without knowing all of this information about your credit and the details of the transaction.
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