How do Mortgage Rates Work?

Many do not quite understand how mortgage rates go up and down.  There are several times the FED changes interest rates and then the calls start coming in asking about mortgage rates because they heard the FED lowered rates.  It doesn't quite work that way.

The FED meets on the FED FUNDS RATE which is the RATE at which the FED lends Banks money.  The FED FUNDS RATE is currently at 2%.  Banks then base their rate on an Index called PRIME which is 3% above the Fed funds rate.  So that currently puts PRIME at 5%.  Prime is an index that is used to lend money on Home Equity Lines of Credit, Auto Loans, Credit Cards, Business Loans, Construction Loans, Ect.  The bank lends money based on a rate of PRIME minus or plus a margin and that determines the rate.  For Example:  We are offering home equity lines of credit at PRIME minus a margin of .375% which equals 4.625% based on credit score and the equity in the home.  That is how PRIME works.  Prime is in no way connected to Mortgage Rates. 

So how do Mortgage Rates work?  Mortgage Rates are based on MORTGAGE BACKED SECURITIES which is a type of BOND traded daily in the market.  The more money that flows into MBS the higher they are in value.  The higher the value the LOWER MORTGAGE RATES GO.  If money flows out of MBS, mortgage rates go back up because the value of MBS are then less. 

Example:  Value of Mortgage Backed Securities are at 101 in price and lets say that equals 6% interest rates.  Tomorrow Mortgage Back Securities improve 40 points.  The day close is now 101.40.  So the higher value of the MBS yields a lower mortgage rate.  Now mortgage rates are 5.875%.  For every 100 points up or down equals approx .25% to .375% in rate depending on the day.  So lets say that we are at 101 pricing today and over the next week it goes up 100 points and now we are at 102.00 pricing.  Mortgage rates would now be approx 5.625%.

So now that we know Mortgage Backed Securities determine mortgage rates lets talk about what drives MBS up or down.  There are several factors that determine what MBS do each day based on the economy.  Below are just a few examples of what drive MBS up or down. 

1. MBS don't like INFLATION or inflation fears.  So if the FED lowers PRIME that gives fear that inflation will go up because the lower PRIME is the money money will be borrowed and spent and therefore inflation could go up.  Because of that if the FED lowers PRIME say today most likely investors will pull money out of MBS therefore lowering the value of them and Mortgage Rates go up.  Another form of inflation is Oil prices.  if oil is very high that could hurt MBS as well and again rates could go up.  There are also inflation reports released every month called the CPI and PPI reports that measure inflation.  if those reports come out and show that inflation is tame there is a good chance that money would flow into MBS and therefore rates come down and vice versa.  Overall, higher inflation news or fears of it in the future can cause rates to go up.  Reports that inflation is going down will help mortgage rates go down.
2. FED Meetings can impact mortgage rates.  When the FED meets they determine if they are going to raise or lower prime.  As i mentioned earlier if the FED keeps PRIME where it is at or raises it that can help to lower inflation and that is good for MBS and mortgage rates.  Also it is very important to note that the wording of the FED in those FED meetings can drastically help or hurt rates based on their statement about the economy. 
3. The stock market a lot of times determines how Mortgage Backed Securities will react.  Not always but most of the time MBS will react opposite of the stock market.  If money flows into stocks then money will flow out of bonds (mbs) and vice versa.  If the stock market is way down on a given day the money flows into mortgage back securities because at the time stocks are down bonds (MBS) can be a safer place for money and therefore mortgage rates improve. 
4. Economic Reports and the importance level can determine if rates go up or down.  Example of reports are CPI & PPI inflation report, FED meetings, Housing stats, Oil reports, Job losses and unemployment rates, Gross Domestic Product report, retail sales and many other reports.  Every day that a report comes out it will usually move Mortgage Backed Securities up or down and rates will react to that. 

There are other things that affect mortgage rates but all the information above will give you a good idea of how they go up and down.  I watch this daily so if you would like to be on a rate watch list please email me requesting to be on the RATE WATCH LIST. 

Phil White 480-430-3080