The Mystery of Mortgage Rates
Mortgage interest rates are a big mystery to most people. Putting aside the obvious influence of your credit score, what drives the baseline mortgage rates up or down? In order to understand this,you need to know what Mortgage Backed Securities are and how they function.
Mortgage Backed Securities (MBS)
The simplest way to explain MBS is that they are pools of money used to loan the money to a home buyer who wants to buy a home. For instance, a banking institution may pool the monies from their deposits to help lend money to homebuyers. However, MBS are not only used by banks. Numerous investors exist for MBSs. Since it is an investment, many of the same factors come into play as with other investments.
- Long Term Delays on Return: Even though mortgages are usually for 30 years, the average mortgage is paid off within 10 years either through refinancing or selling the property. This is still a very long time and MBS investors factor the uncertainty of interest rates over such a period in their calculation.
- Prepayment Risk: While investors want to get their money back from homebuyers, they don’t want to get it back too soon as they are counting on the monthly mortgage for their return. One factor they consider is the risk of having it paid off too soon.
- Lack of Access: Whether it is for 1 year or 30 years, the money that MBS investors put into a mortgage causes the lost of liquidity for them. In other words, they cannot just go into a bank account to withdraw it if they need it. As a result, the loss of quick access (liquidity) effects the calculation.
- Inflation: This is an “evil” word and used to be a much bigger issue 35 years ago. However, even at our current annual inflation rates of 2-3%, this is a factor. A dollar today is worth less than the same dollar tomorrow. The buying power of money goes down over the course of time. Consequently, investors will look use data about inflation to help calculate the cost of lending their money.
Most MBSs use the 10 years treasury bond note yield as a baseline to start their calculation. This is not a direct relation to anything relevant, but it is a common basis for the baseline rate determination. Why? Because the average payoff time frame is 10 years on most mortgages.
Since the 10 year bond yield is so relevant, many of the usual factors that impact this yield will affect mortgage rates. This includes inflation rates, unemployment, GDP, and many of the traditional economic reports. Mortgage interest rates will generally go up fairly quickly if the yield starts going up. However, if the yield should start dropping, rates will come down at a slower rate. The reason for this is that bond yields can fluctuate throughout a day. Mortgage rates are generally set on a daily basis so there is a time lapse that is taken into account and is tracked over periods of time.
This is just the beginning of the description for determining mortgage rates. Heading into 2018, we are seeing 10 year yields dropping while short term yields rising. This has been associated with slowing economic times in the past but it also signals continuing low mortgage rates. If you’d like to schedule a time to discuss these, feel free to contact your Mortgage Genie who makes each family’s home dream come true one wish at a time.