Why Do Mortgage Rates Go Up & Down?

Changes in Treasury Bonds

Treasury notes are bonds that are issued and backed by the United States government, which virtually guarantees that it will be paid back. Mortgages are less secure, because even individuals with the best credit scores can be hit with extended unemployment or sickness, so the mortgage rates will be higher than bond rates.

Inflation is the rate at which prices rise. As prices go up, the purchasing power of a dollar goes down. Since you will be paying back the lender years from when you take out the loan; if you were to pay back the lender the same amount as you borrowed, the lender would lose purchasing power. For example, if you borrowed $10,000 in the 1950s, the could almost buy a house. If you only paid that same $10,000 back decades later, the lender might be able to afford only a down payment on a house because of inflation. The higher the rate of inflation the higher the interest rates on mortgages will be.

The Federal Reserve does not set interest rates. Instead, it only suggests the bank-to-bank overnight rate. This is the rate at which banks borrow money from each other. In some economic situations, when this rate falls, mortgage rates will increase because the Federal Reserve cutting rates may be interpreted to mean the economy is fragile.

Even in the worst of times, the federal government is still highly unlikely to even consider defaulting on its loans. However, when the economy is in a depression, individuals are at a much greater risk to lose a job and not be able to repay the mortgage. Therefore, the mortgage rates will rise much more than the price of other securities because the risk involved in a mortgage has increased. In booming economic times, the chances of a mortgage being defaulted on goes down.

When banks and other financial institutions lend money in mortgages or when investors buy mortgages on the secondary market, they are tying up money in that investment. Investors are looking to maximize their profits, so if other investments like stocks are yielding significantly higher return than mortgages, there will be fewer funds available for mortgage borrowers. The competition for these limited funds will drive up the mortgage rates.