What Drives Mortgage Rates Up or Down?
Purchasing a home is a large expense. Because of the cost associated with buying a home, most people obtain mortgages to pay the seller the balance of what they are due. How much a buyer can afford depends on the amount of money being borrowed and the interest rates charged by the lending institution. For instance a borrower looking for $100,000 on a fixed-rate term of 30 years at 5 percent would pay about $536 per month for the loan. If the rest of the terms are kept the same, but the bank offers an 8 percent loan, that monthly payment would be $733 per month.
Other People Are Reading
-
Mortgage-Backed Securities
-
When someone obtains a mortgage from a bank, that mortgage is then usually sold in another marketplace to a secondary lender. In the same way that stocks and bonds are traded on a regular basis, so too are these instruments, called mortgage-backed securities. They work on a supply-and- demand system just like stock. If there is a higher demand, then interest rates rise. If demand falls, then interest rates fall as well.
Risk Premium
-
A risk premium is built into every mortgage. It takes into account the possibility that a borrower may default on the loan and not be able to repay the balance due on the note. Borrowers with better credit have a lower risk premium than borrowers with poor credit. Borrowers with poor credit are known as "sub-prime" borrowers. If there is a period in which lot of defaults are taking place, than the risk premium will be raised to offset that risk. Conversely, in a period of low defaults, that risk premium will be lowered.
-
10-Year Treasury Note
-
Because mortgages are sold off to other investors in secondary markets, those investors want to obtain the best possible return on their money, while limiting risk. The U. S. federal government also sells investment vehicles in the form of bonds. These are known as Treasury Bills or T-bills. Treasury bills are backed by the U.S. government, meaning is virtually no risk of default. To entice investors away from T-Bills, mortgages must provide a higher rate of return. Typically that rate is about 1.7 percent higher than the T-Bills. Although there is no direct correlation to the 10-year Treasury note, typically as the 10-year note rises, so do mortgage rates. Likewise as it falls, rates fall as well. Investors look at the 10-year rate since a 30-year mortgage typically is not held more than 10 years, as borrowers move or refinance.
-
References
Resources
- Photo Credit home sweeet home image by .shock from Fotolia.com
