Why Do Mortgage Rates Change Every Day?

Mortgage rates change every day which affects how much you pay for your house.

Home mortgages make up the largest debt owed by most households. Likewise, the value of their home and the resulting equity is their largest asset. Small changes in mortgage interest rates can push up the payments of adjustable rate mortgage holders. These same interest rate shifts can make refinancing or buying a new home more or less expensive for everyone. Although analysts and economists try to make predictions with their interest rate forecasts, rate fluctuations can be difficult to predict. With so much energy focused on interest rates, it is only natural to wonder why do mortgage interest rates fluctuate on a daily basis.

History

The Federal Reserve Board and the Federal Reserve Banks are designed to help manage the U.S. economy and protect the viability of the overall banking system. One mission of the Fed is to manage the monetary supply to prevent high inflation and to help protect against deep recession. The most visible tool used in this mission is the Fed's power to set short-term interest rates. However, the Federal Reserve Board only meets quarterly, and changes to interest rate policy are not frequent.

Misconceptions

Many Americans get too caught up in the idea that the Federal Reserve "sets interest rates." In fact, the Federal Reserve only actually sets one interest rate. The discount rate is the interest rate that the Federal Reserve charges banks for short-term loans directly from the Fed. This rate is directly set by the Fed. The federal funds rate, on the other hand, is a "target" that the Fed maintains by injecting or removing funds from the monetary system. This rate is what banks charge each other for very short-term loans. Both rates greatly influence short-term interest rates charged by banks. However, the Fed does not set any long-term interest rates.

Function

Mortgages are long-term loans. Any loan with a term of 10 years or longer is considered a long-term loan. Most mortgages have a 30-year term, although shorter terms are not uncommon. Long-term interest rates are established in the open markets similar to stock prices. Investors buy and sell bonds and other securities. All things being equal, a higher interest rate is worth a higher price than a lower interest rate. Supply and demand establishes an equilibrium. The rate of return at this point can be considered the current market interest rate. It is measured by various interest rate indexes.

Theories/Speculation

The graphical representation plotting interest rates with their terms is called the yield curve. A "normal" yield curve exists when very short-term loans may have very low interest rates. Interest rates tend to rise gradually as the term lengthens with a three-year loan having a rate a little higher than a one-year loan, and a little lower than a five-year loan. The loans with the longest terms, therefore, have the highest interest rates.

In certain circumstances, long-term loans can have lower interest rates than loans with a shorter term. This situation is known as an "inverted" yield curve.

Potential

Bonds are traded every day except for weekends and market holidays. The constant ebb and flow of supply and demand determines the price of any given bond. The movement of these individual prices can also change the "price" of indexes tied to those investments. Mortgage rates are set by lenders based upon the level of a public bond index or an in-house index plus an additional amount, or spread. Since the indexes change daily, mortgage rates change daily as well.

References

• U.S. Treasury: Treasury yield curve rates FAQ
• Relationship between discount rate and mortgage rates
• New York Federal Reserve: Interest rates introduction