Many people think that mortgage interest rates move in correlation with the Federal Funds Rate. But what they don’t know is that the Fed’s actions have little or no effect on mortgage interest rates.
For example, the Fed has kept the Fed Funds rate between 0-0.25 percent since 2008. Yet, interest rates have risen and fell several times in recent years. Currently, they are at historic lows. They have never been lower than they are right now. Why? The answer isn’t simple, but we’ll take a stab at giving a condensed explanation.
Mortgage rates move like bond rates (yield). The duration of the bond (mortgage) is the risk. For instance, a 30-year mortgage has a higher risk than a 15-year mortgage of:
- Prepayment / default (paying off)
- Fluctuation in the future value of the dollar (inflation / deflation)
- Change in type of loan (investment, second home)
The increased duration for the mortgage means there is greater risk of default or paying off early. But investors need payment in return for tying up their money for a longer period of time. Mortgages compete with other investments in the market.
The best way to gauge interest rates is to watch the treasury market. The treasury market is the best gauge for mortgage interest rates because the government’s debt is the safest debt in the world. The United States Dollar is the world’s reserve currency. Because the average lifespan of a mortgage is seven years, the best indicator for mortgage interest rates is the 10-year treasury.
This topic is really far more complex than as explained above. I hope this gives you some sort of idea how mortgage interest rates move up or down.