How the Economy Affects Mortgage Rates

The interest rates on mortgage loans have a direct effect on how much money will have to be repaid on a home.

While home buyers are always aiming for the lowest interest rates possible, lenders have to cover for the risk by adjusting their interest rates accordingly.

Only buyers with a great credit history and solid incomes usually have access to the lowest rates because of the low risk they represent.

However, while certain personal factors will have a direct effect on how much you’ll pay on mortgages, many factors out of our control can have a direct incidence on mortgage rates.

Family home

Here are some of the factors that may affect mortgage interest rates.

Inflation

The incremental inflation of prices has a direct effect on purchasing power and is of capital importance for mortgage lenders. Lenders usually have to adjust their interest rates to compensate for the erosion of purchasing power represented by inflation rates so that they can still make a profit. If mortgage rates are presently at 6%, and annual inflation is 2%, the lender only gets a 4% return when factoring the erosion in purchasing power.

Economic Growth

Many economical factors such as GDP and employment rates have a direct incidence on mortgage rates. During periods of economic booms, more people are looking for mortgages which drives the demand up. This has the effect of pushing mortgage and interest rates up across the board. On the other hand, when the market is timid, interest rates tend to be lower because of decreased demand.

Federal Reserve

The Federal Reserve’s fiscal policy plays a major role in interest rates and the economy as a whole. The Federal Reserve doesn’t directly dictate interest rates for the whole industry, but the Fed Funds Rate will usually have a trickle down effect across lenders. The FED also controls the money supply, which also has a direct effect on interest rates. Usually, when the FED limits the money supply, interest rates go up because of scarcity. The opposite is also true when the FED increases the money supply.

The Bond Market

Many banks and lenders offer mortgage backed securities as financial instruments. However, for these debt backed securities to be profitable, they have to yield returns high enough to attract buyers.

Governments also offer competing long term fixed income investment solutions in the form of bonds, and the state of the bonds market has a direct effect on MBSs. This therefore has an indirect effect on mortgage rates by forcing lenders to adjust the rates on their MBSs to be able to compete with government bonds.

When trying to calculate interest rates, mortgage lenders usually use a variety of governmental benchmarks. One of them is the 10 year Treasury bond yield. On average, the yield offered on MBSs over 10 year treasury bonds is around the 1.7% mark. MBSs have to offer higher rates than regular bonds since they are not guaranteed.

Different Housing Market Conditions

Many conditions affecting the housing market can have a direct effect on mortgage rates as a whole. When the market is slow and there are less homes being built and bought, this usually puts negative pressure on mortgages and lenders have to adjust their rates to attract buyers. Another factor that might affect mortgage rates is how many people decide to rent rather than owning. More renters means less buyers, which also tends to push mortgage rates down as a result.

Conclusion

Mortgage rates usually follow the laws of supply and demand, and once you understand these principles, it is easy to understand how mortgage rates fluctuate.

On average, when money supply is low and demand for mortgages is high, interest rates tend to go up. In times of excessive inflation, mortgage rates tend to go up as well. Keeping a close eye on the Fed Funds Rate should also give you insight on which way the interest rates will go. And last but not least, competing financial instruments such as government bonds may have an insidious effect on mortgage rates that should be neglected.

All these factors will need to be taken into consideration when seeking a fixed or variable mortgage or seeking an equity line of credit. This will also affect FHA loan rates in your area. If you’re thinking of getting an FHA loan, it would be wise to keep a close eye on interest rates in your area to see if they’re the right choice for you. Before you start looking for guaranteed FHA loans in NJ, for instance, check out the interest rates in your area to make sure that they are advantageous.

Knowing how mortgages fluctuate is essential if you want the best possible deal on your mortgage. It will also allow you to avoid unpleasant surprises in case you decide to go for a variable rate mortgage.