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What Makes Mortgage Interest Rates Change?

April 24, 2014
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We have heard for several years now that mortgage rates are at “historic lows.” And it’s true. Back in the early 1980s mortgage rates hovered in the mid-to-high teens. Think of the difference between an 18% home mortgage then, compared to today’s sub 5% interest rate loan. It is truly remarkable. But what drives the ups and downs of mortgage rates?

Monetary policy

It begins with monetary policy: The Federal Reserve tweaks the U.S. financial system by raising or lowering the federal funds rate – the interest rate banks charge each other for short-term loans. In turn, because they are based on the future value of short-term interest rates, long-term rates such as corporate bonds and mortgages are ultimately influenced, as well.  The ripple effect moves interest rates across the spectrum, from business borrowing to consumer loans.

Market movements and inflation

Individual mortgage loans are often bundled with thousands of others into mortgage-backed securities. The secondary market for these investments can also move interest rates offered by mortgage lenders.  If the cost for consumer goods rises, the dollar loses a bit of its buying power and the resulting inflation impacts spending – and the bond market.

If inflation threatens, interest rates are boosted to tame the economy and maintain the strength of the dollar. Mortgage securities begin to sell off and prices fall. But because of the “see-saw” inverse relationship between bond yields and bond prices, as prices fall, yields rise. Those rising yields are a direct influence on mortgage interest rates. Inflation causes higher prices for everything, including home loans.

When the threat of inflation is slight, mortgage interest rates usually remain low.

The economy

Interest rates influence economic behavior as well. In a low interest rate environment, businesses are eager to borrow, make capital expenditures, expand their businesses and hire more employees. Personal wealth rises and fuels the fire for even more spending. The housing market booms during periods of low mortgage rates.

As interest rates rise, the cost for such expansion becomes ever more expensive – businesses become more cautious, discontinue plans for development and often begin headcount reductions. Housing construction weakens and home sales typically become sluggish as mortgage rates rise.

Global factors guide mortgage rates, too

All of these economic variables are interrelated and affect the supply and demand for housing. A weak economy keeps the Federal Reserve busy massaging the money supply with low interest rates. A strong economy induces the Fed to raise rates to stem potential inflation.

But global factors also impact the U.S. economy, including mortgage interest rates. Political unrest, increasing foreign competition, unemployment, fuel and food costs – anything that threatens – or bolsters — the American economy can influence the cost of borrowing money. Whether you are a first time home buyer or seeking a mortgage refinance, learn more about how to get the best mortgage rates for your situation with NerdWallet’s mortgage guide.

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