What Drives Interest Rates?

What causes mortgage interest rates to go up and down? The answer to this question is not always simple, and can change depending on who you talk to. But there are certain factors that affect interest rates and drive them in different directions.

Some people mistakenly believe that the 30-year Treasury has an effect on the rise and fall of interest rates, but most experts do not consider this to be true. They may sometimes be linked coincidentally, but in the end, mortgages aren't connected to 30-year bonds.

They are not linked because mortgages, especially in today's financial climate, are short-lived when compared to Treasury Bonds, which last 30 years. A better indication of where interest rates are going is the 10-year Treasury Note, due to its shorter lifespan, although this still isn't the most significant factor at play in the case of interest rates.

Federal rates do affect interest rates, but not in the way you might suspect. The rates will move up or down depending on what the experts anticipate the Feds will do – they don't necessarily change according to what actually occurs.

So if everyone expects the rates to go down, lenders price mortgage rates accordingly. If it seems no more rate cuts are on the horizon because the economy is doing well, it's more than likely that mortgage rates will rise.

Often homeowners expect a drop in rates by the Feds to directly correlate to a drop in mortgage rates. Unfortunately, this is not always the case. The Federal Reserve only cuts the Federal Funds Rate or the Discount Rate, which is short-term, especially in the eyes of the banks. Lending institutions don't adjust fixed-rate mortgages depending on the rate banks charge one another to borrow money, which is exactly what the Federal Reserve Rate reflects.

Banks use this rate to borrow money from each other overnight, so each institution can meet its reserve by the end of the day. They must have more cash on hand than they have out in outstanding loans, and borrow to make up the difference. The rate at which the banks borrow in this process is what the Federal Reserve cuts when you hear these announcements – it has nothing to do with mortgage rates.

These rates may indicate where the market is going in the next while, but don't affect mortgage rates directly or on the spot.

Instead, mortgage rates are tied to mortgage-backed securities, such as Fannie Maes and Ginny Maes. Lenders pay close attentions to these figures and price their mortgages with them in mind. Market position and loan stimulus also affect mortgages.

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