Mortgage interest rates change daily, Monday through
Friday, and may change during the day if market events justify their movement.
Although interest rates are tied directly to the "mortgage backed securities" (MBS)
market, an easy indicator for their movement is the 10-Year Treasury bond. The
bond information is readily available on cable news programs and in daily
newspapers. Usually what you will see posted is the bond yield in a percentage
form (i.e. 4.75%). When the yield goes up, rates go up and vice versa. While
interest rate movements are not strictly tied to such movements in the bond, you
can use it as an indicator of what also may be happening to home loan rates.
Besides numerous outside influences which can effect the mortgage market just
like the stock market (i.e. world events), there are other direct influences
which may make interest rates change.
Because mortgage interest rates change daily; over the course of several weeks
or months, these fluctuations can add up to big changes. For instance, if
interest rates went from an average of 5.77 percent to 6.33 percent it could add
$100 to the monthly payment on a $150,000 mortgage.
vs. adjustable-rate mortgages
Mortgages can be structured in a multitude of ways, but when it comes to the
interest rate, there are really only two varieties of mortgages: fixed-rate and
adjustable-rate. In a fixed-rate mortgage, the interest rate and your monthly
payment remain unchanged for the life of the loan (until you pay off the
mortgage, refinance or sell your home, whichever comes first).
By contrast, the interest rate of an adjustable-rate mortgage (ARM) changes –
which means your payment can change too. If interest rates rise, your payments
could go up. If rates fall, your payments could go down. Because you, the
borrower, are assuming more risk (via changing payments), lenders are willing to
charge you less interest. Hybrid adjustable-rate mortgages offer an initial
period of fixed-rate interest – usually three, five, or seven years. (The longer
the fixed-rate period, the less of a discount on the rate you tend to get.)
Hybrid ARMs can allow borrowers to benefit from an adjustable-rate interest rate
with fixed-rate predictability.
interest rates to rise and fall?
Economic factors influence interest rates. Both short- and long-term interest
rates are affected by economic factors such as inflation, the strength of the
U.S. dollar and the pace of economic growth.
For example, strong economic growth can lead to inflation. If the Fed becomes
concerned about inflation, it may attempt to cool the economy by raising the Fed
funds rate, as it did in 2004 and 2005.
On the other hand, if the economy slows down, the Fed may lower the Fed funds
rate to stimulate economic growth, as we witnessed in 2001-2003. Similarly,
economic factors also affect long-term interest rates. For example, over the
summer of 2003 and then again in the spring of 2004, long-term interest rates
rose from historic lows as the economy showed signs of strength.
It should be noted that short- and long-term interest rates don't necessarily
move in tandem. While short-term rates rose in 2004 and 2005, long-term rates
remained relatively low.
The Federal Reserve does not control mortgage rates. The
Federal Reserve controls the Fed Funds Rate.
The Fed Funds Rate is a short-term interest rate, and its function is to make
money more costly to borrow, or less costly to borrow for homeowners and
business owners. This works because many bank loans are based on the Prime Rate
(which is 3.000% higher than the Fed Funds Rate).
As Fed Funds Rate goes up, so does Prime Rate. And, as Prime Rate goes up, so
does the cost of borrowing money. The reverse is true, too, if the Fed Funds
Nowhere, you'll notice, do we mention mortgage rates in connection with the Fed
Funds Rate. That's because mortgage rates are based on the mortgage-backed
securities market -- a global exchange similar to the NYSE or NASDAQ. The Fed
doesn't operate in these markets.
Mortgage-backed bonds are considered long-term products and pricing is based on
long-term expectations of the U.S. economy and the U.S. dollar.
Where Does the Money Come From for Mortgage Loans?
Mortgage Backed Securities
Once Freddie Mac, Ginnie Mae, and Fannie purchase the pools, they break them
down into smaller ownership parcels. These are called "mortgage backed
securities." Each security represents a small ownership interest, not in your
specific loan, but in the pool of which your loan is only one part. The risk is
therefore diversified and it is a very safe investment.
The mortgage backed securities are sold on Wall Street to institutions or
individuals looking for a safe investment, but one that earns a higher interest
rate than treasury bonds. You may even own some as part of your retirement fund
or investment portfolio. Perhaps you have heard of Ginnie Mae bonds? Those are
securities backed by the mortgages on FHA and VA loans.
By selling the bonds, Ginnie Mae, Freddie Mac, and Fannie Mae obtain new funds
to buy new pools so lenders can get more money to lend to new borrowers.
And that is how
the cycle works.
So when you make your payment, the servicer gets to keep their tiny part, and
the majority is passed on to the investor. Then the investor passes on the
majority of it to the individual or institutional investor in the mortgage
From time to time your loan may be transferred from the company where you have
been making your payment to another company. They aren't selling your loan
again, just the right to service your loan.
There are exceptions.
Loans above $417,000 do not conform to Fannie Mae and Freddie Mac guidelines,
which is why they are called "non-conforming" loans, or "jumbo" loans. These
loans are packaged into different pools and sold to different investors, not
Freddie Mac or Fannie Mae. Then they are securitized and for the most part, sold
as mortgage backed securities as well.
This buying and selling of mortgages and mortgage backed securities is called
"mortgage banking," and it is the backbone of the mortgage business.
How are short- and long-term interest rates different?
The Federal Reserve Board controls the federal funds rate. The Federal Reserve
Board (Fed) has the power to raise or lower the federal funds target rate (Fed
funds rate), which in turn influences the market for shorter-term securities.
The Fed funds rate is the rate banks charge other banks for overnight loans. The
Fed may raise the rate to keep inflation in check or lower it to stimulate the
Long-term rates are market driven. Long-term interest rates, as represented by
yields of the 10-year or 30-year Treasury bond, tend to move in anticipation of
changes in the economy and inflation.
History of Mortgage Interest Rates
rates are considered to be at an almost all time low. Back in the late 70s and
well into the late 80s, it was not uncommon for someone to have a double-digit
interest rate on their mortgage loan. In fact, back in December of 1980,
interest rates averaged 21.50 percent on mortgage loans. Someone borrowing
$200,000 on a 30-year loan term during that year would have a monthly payment of
$3,589. With today's interest rates, a $3,589 payment on a 30 year loan would
mean that you have a $630,000 house.
During the last three decades, interest rates have stayed relatively low. The
rate being paid now on a 30-year mortgage loan is very similar to the rate that
was paid back in the 60s.
Between 1973 and
1990, double-digit interest rates were the norm. Rates didn't fall to
single-digits until 1991, when the average annual rate on a 30-year mortgage
loan was 9.25.
The Future of Mortgage Interest Rates
It is very difficult to determine what will happen to the economy and the
market, and what The Fed will do as a result. Interest rates may stay low for a
long period of time, or they may begin to slowly creep up until they match or
extend past the high rates of the 70s and 80s.
Many analysts are predicting that rates will remain low through 2010, but these
predictions are nothing more than good guesses at best. If you want to predict
what interest rates will do, you can also look at the history of mortgage
interest rates, study the economy, and the models used by The Federal Reserve.
Remember though, there is no way to tell for sure what the future will bring for
mortgage interest rates.