How are mortgage interest rates determined
To know how are mortgage rates are determined, we need to know what indicators to watch in order to better understand the circumstances on how and why interest rates fluctuate.
Generally speaking, when we think of what determines the fluctuation in mortgage rates there are a couple of suspects that come to mind. We may suspect the banks, or the big players in the markets such as Freddie Mac or Fannie Mae, or possibly the federal reserve has something to do with how mortgage rates are determined. These are factors , however there is a much larger picture at play.
When taking out a mortgage, the lending institution or mortgage company is loaning you an amount based at a given interest rate. Howver , in most cases, the bank will sell your mortgage to a financial institution that basically packages that with other mortgages. This is what is called a mortgage back security in which in turn is sold to other investors on the global market. In essence, to put it simply, we are talking about the business of selling debts.
How are Mortgage Rates Determined ?
It may seem strange that anyone would buy a debt, however, the investor, whether its a large investment firm or mutual fund will earn their return by collecting the interest payments that the mortgage borrower has to make.
The banks and financial institutions that sell mortgage backed securities have to offer competitive rates of interest to investors that are comparative to other interest paying investments, a good example of this would be Treasury Bonds.
Something to note is that a thirty year mortgage may not necessarily track the same as a thirty year treasury bond even though they are of the same length of term. Sometimes in many instances, thirty year mortgages might still remain outstanding after ten to twelve years, which in effect tends to track the yields on ten year treasury bonds.
That being said, mortgage interest rates are slighlty higher than the rates of ten year treasury bonds.
A thirty year mortgage rate will be around 2 percentage points higher than that of treasury bonds, but the fluctuation or spread can vary somewhat depending on the demand for mortgage backed securities or treasuries and of course inflation is a large factor with determining mortgage interest rates.
Speaking of inflation, this is a factor that is highly dependent on the belief system of the investors in the market as a whole. Interests rates will tend to increase if investors believe there will be a significant rise in prices in the future.
We are talking about a fear based system that has seen many major domino effects due to uncertainties in the market . Having said that, the bottom line is that if investors believe there will be a rise in inflation, they will demand higher interest rates paid to them as a buffer
against possible dilution of the future value of their mortgage backed securities.
This phenomenon also works the other way, in that if investors believe there will be a drop in inflation in the future , the interest rates will fall because they would be willing to accept lower interest rates in return from their investments.
This is a very basic and rudimental explanation of how are mortgage rates determined, if you are interested delving a little deeper into the complexities of the market, just subscribe to loans-online-resources.com Rss Feed for upcomming articles and more information.
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