What causes mortgage rates to change?
What causes mortgage rates to increase and decrease? The answer first? Inflation and supply and demand are the two main factors that affect mortgage interest rates. That statement should be prefaced with the fact that a consumers qualifications are also a large factor in an interest rate, but inflationary pressures and the availability of mortgage money are the two biggest external factors. It is important to note that neither the Federal Reserve Board nor the U.S. government have anything to do with the determination of mortgage interest rates. Mortgage rates are set by mortgage lenders, reacting to many different economic factors. In order to understand this answer, it is best to start with an understanding of bonds.A bond is “an interest-bearing certificate issued by a government or business promising to pay the holder a specified sum on a specific date, as defined by Websters Dictionary. Guaranteed certificates with a fixed rate of return are sold by the U.S. government in the form of U.S. Treasury bills, notes and bonds. All of these are debt instruments sold to investors, with guaranteed rate of return, to raise money for the government.Mortgage companies and banks operate in the same manner by selling their debt instruments in the form of mortgage-backed securities. Simply put, mortgage-backed securities are bundles (in the millions of dollars) of U.S. mortgages sold to investors just like U.S. bonds. U.S. mortgage-backed securities have a fixed interest rate and return just as U.S. government debt does. The difference is that mortgage-backed securities are backed by U.S. homes, as opposed to being backed by the credit of the U.S. government. Both debt instruments are considered safe because of their backing and fixed rate of return.Inflation is considered the enemy of any fixed-rate investment tool. The fixed rate investment tool of a U.S. bond or a mortgage-backed security will yield no more or no less as the term passes. But, what happens if the price of milk and cookies keeps going up or inflating? The buying power of the fixed rate of return is diminished. This is the risk or argument against any sort of fixed rate of return investment. The investment may not keep up with the rate of inflation.Therefore, any sort of inflationary report or precursor is going to cause mortgage rates to increase because the buyers of mortgage-backed securities are fearful of their investment becoming less valuable. In order to entice investors to keep buying their debt instruments, lenders and banks must keep up with the pace of inflation and raise interest rates. Supply and demand is also a key factor in the mix of interest rates. The purchase of mortgage backed securities keeps mortgage money available to U.S. consumers. As well, it keeps the companies that sell the securities in business. Any disruption in the cycle, or failure to buy the securities, will cause mortgage rates to increase due to lack of supply on the consumer end of the equation. Both of these circumstances have been occurring recently. A rate reduction by the Federal Reserve Board on Sept. 18 made short-term money more readily available in an effort to spur a perceived stalling U.S. economy. In economic theory, cheaper short-term interest rates and money will lead to increased production and consumption which will lead to increased inflation. Therefore, mortgage rates actually increased with the news of the Fed funds rate decrease. Simplified, the recent sub-prime mortgage debacle,” or specifically the failure of some sub-prime mortgage-backed securities, has led to a decrease in the purchase of all U.S. mortgage-backed securities. This is due to fear of defaults and foreclosures of mortgages within the U.S. and within these securities. Therefore, mortgage rates for many scenarios have increased due to a lack of mortgage money being re-supplied.Mortgage interest rates fluctuate on a number of different complicated factors and variables. These factors and variables change quickly on a day-to-day basis, but there are underlying patterns predicting the future direction of interest rates. In this ever-changing environment, it is vital to entrust your mortgage financing to an educated, knowledgeable and seasoned professional. William A DesPortes is a managing member of DesPortes, Selig & Associates, Professional Mortgage Services. He can be reached at 970-949-0653 or firstname.lastname@example.org.
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