Long Term Mortgage Interest Rates Are Determined By The Treasury Bond & Stock Market
Yields on 10-year treasury bond securities are typically used to set long-term mortgage rates. Loans with short initial terms (1-, 3-, and 5- year ARMs, e.g.) are pegged to shorter-term treasury bonds. So when bond yields drop, typically, conventional mortgage interest rates fall as well. Conversely, when yields rise, so do mortgage interest rates.
Why are mortgage rates tied to the bond market?
If a lender chooses to sell your mortgage loan to an investor, the lender will likely use Treasury yields as a benchmark for value of your mortgage note.
Stocks & Bonds Compete
Many clients believe there is a direct relationship between the Federal Reserve and interest rates, when in actuality, stocks and bonds have a greater effect on mortgage rates.
There is a dynamic that has been occurring over the past 36 months or so, which is the competition for money between stocks and bonds, specifically the NASDAQ and mortgage-backed securities. As we all can relate to, many clients think the Federal Reserve has a direct relationship and impact on mortgage interest rates. In fact, nothing could be further from the truth. The real relationship is between stocks and bonds. The following script is one that I encourage you to deliver if you are engaging in conversation with a client about the subject matter of interest rate movement.
An example conversation on this very topic:
Mr. Jones, stocks and bonds are competing for the same investment dollars on a daily basis. It is important that you understand, there is only so much cash out there on the sidelines to be invested. Now, when we have economic data that indicates we have a slow-down occurring in our economy, people tend to sell their individual securities and they need a safe haven for that money. That safe haven is typically bonds and mortgage-backed securities.
When we have economic data that growth is occurring in the economy, and we are in an upward trend (bull market), the stock market typically rallies. In a bull market investors usually liquidate there bonds to invest in stocks or equities which will give them a higher ROI (Return On Investment).
This does not always hold true, but typically speaking, when the stock market is having a very strong day, mortgage interest rates are going up, because mortgage-backed securities are being sold to fuel the stock market rally. Conversely, when the stock market sells off, people are liquidating and selling those individual stocks and placing that money in mortgage-backed securities. Those purchases of mortgage-backed securities drive interest rates down.
