Mortgage rates fluctuate over time as a result of the interaction of the supply and demand for money in the economy. For mortgage borrowers, changes in either of these factors affect the interest rate lenders charge prospective homeowners.
Naturally, home buyers prefer lower mortgage rates to minimize the long-term cost of borrowing. Tracking the economic developments that influence mortgage rates helps with understanding how these rates are determined.
The economy grows and shrinks and is very sensitive to events within itself as well as outside. For instance, low unemployment rates indicate that the economy is producing more and moving toward growth.
However, this growth may be hampered by non-economic shocks like wars and natural disasters. When the economy is on a growth path, the demand for money increases and interest rates are pushed upward. The opposite is true when economic growth slows or stops.
A key concern during periods of economic growth is inflation. Inflation increases prices and deteriorates spending power in the economy, which slows growth.
The implication for future homeowners is that inflation pushes mortgage rates higher as lenders increase interest rates to hedge against the effects of inflation on profits, making the home buying procedure more expensive.
Economic activity is measured nationally to determine the appropriate interest rate. For example, the Federal Reserve Board, which is the central banking authority in the United States, measures economic growth through 12 Federal Reserve branches across the country.
Federal Reserve branches collect economic information from their respective regions and report to the Federal Reserve Board during regular meetings in Washington, D.C. The outcome of this meeting determines whether the Federal Reserve will try to increase interest rates to control growth or decrease rates to spark growth and encourage borrowing.
Although the Federal Reserve is unable to directly set interest rates, the agency can influence rates indirectly by increasing or decreasing the supply of money in the economy.
By increasing the money supply, the Federal Reserve puts downward pressure on interest rates. Decreasing the money supply puts upward pressure on interest rates. Consequently, if the Federal Reserve decreases interest rates, mortgage rates come down and borrowing for a home purchase is cheaper and encourages home buying.
In addition to regular monitoring by the federal government, the financial markets establish benchmarks to understand where interest rates might be headed.
For example, the yield on the 10-year treasury bond is widely considered to be a benchmark for long-term mortgage interest rates. As a result, lenders often tie mortgage rates to the 10-year treasury bond to keep the mortgage loan profitable in the long run. Any changes in the 10-year treasury bond yield influence how mortgage rates are set for current mortgages.
