The entire long-term cost of financing the purchase of a property is significantly influenced by mortgage interest rates. Mortgage borrowers, on the one hand, aim for the lowest mortgage interest rates. The interest rates that mortgage lenders charge, however, are how they must control their risk. Only customers with the best credit histories are eligible for the lowest mortgage interest rates.
While a borrower’s financial situation influences the interest rate that will be charged on a loan, economic conditions and governmental monetary policy have an impact on the whole range of mortgage rates. There are five main elements at work, and each of them in some way reflects the fundamentals of supply and demand. Even though some of the underlying causes are complicated, knowing these concepts helps you to understand why you are now paying the interest rates you are and how they could change in the future.
Investopedia / Alison Czinkota
For mortgage lenders, the steady rise in prices brought on by inflation is a key component in the economy as a whole. Over time, inflation reduces the buying power of money. In order to guarantee that their interest returns constitute a true net profit, mortgage lenders typically must keep interest rates at a level that is at least adequate to counteract the loss of buying power due to inflation.
When yearly inflation is 2% but mortgage rates are 5%, for instance, the true return on a loan in terms of the buying power of the money the lender receives back is only 3%. As a result, mortgage lenders closely track the rate of inflation and modify their rates as necessary.
The Rate of Economic Growth
Mortgage rates are influenced by economic growth metrics like GDP and the employment rate. Higher salaries and more spending by consumers, especially those looking for mortgage loans to buy homes, are two effects of economic expansion. This is advantageous for a nation’s economy, but the increase in demand for mortgages as a whole often results in higher mortgage rates. The cause is because lenders can only lend so much money.
On the contrary, this happens with a declining economy. The loss in employment and salaries results in a reduction in the demand for mortgages, which pressures mortgage lenders to provide lower interest rates.
Federal Reserve Monetary Policy
One of the most significant variables affecting the economy generally and interest rates particularly, including mortgage rates, is the monetary policy that the Federal Reserve Bank pursues.
The particular interest rates in the mortgage market are not determined by the Federal Reserve. But it has a big influence on the interest rates accessible to the borrowing public when it sets the Fed Funds rate and modifies the money supply upward or downward. In general, as the money supply expands, rates tend to decline whereas as it contracts, rates tend to rise.
The Bond Market
Mortgage-backed securities (MBSs) are sold as investment products by banks and investment companies. To attract purchasers, the yields on offer from these debt instruments must be sufficiently high.
Government and corporate bonds both provide competitive long-term fixed-income investments, which plays a role in this equation. The returns offered by MBSs are impacted by the profits you may make on these rival financial products. How much lenders charge for mortgages is indirectly impacted by the general state of the bigger bond market. For MBSs to compete in the market for all debt securities, lenders must provide enough returns.
The 10-Year Treasury bond yield is one commonly used government-bond benchmark to which mortgage lenders routinely tie their interest rates. As opposed to government bonds, where repayment is completely assured, MBS sellers often have to provide higher returns.
Housing Market Conditions
Mortgage rates are also impacted by housing market trends and circumstances. When there are fewer new construction or resale houses available, the reduction in home purchases causes a decline in the demand for mortgages, which drives interest rates down.
An uptick in consumers choosing to rent rather than buy a home is a recent trend that has lowered rates as well. Such variations in the supply of properties and customer demand impact the levels at which mortgage lenders set lending rates.
The Bottom Line
Mortgage rates are tied to the basic rules of supply and demand. Factors such as inflation, economic growth, the Fed’s monetary policy, and the state of the bond and housing markets all come into play. Of course, a borrower’s financial health will also affect the interest rate they receive, so do your best to keep your’s as healthy as possible.
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