What Determines Mortgage Rates?

What are the determining factors of mortgage interest rate?  We often hear that the mortgage rate is linked to yields of long term bonds and inflation.  Here is the basics.

1. Federal Reserve (FED) Rate:

   • The FED sets the short-term interest rates for banks.
   • When the FED rate goes up, borrowing money becomes more expensive for banks.
   • Banks pass these higher costs onto consumers, leading to higher mortgage rates.

2. Inflation:

   • Inflation measures how much prices are rising over time.
   • Higher inflation means money loses value quicker.
   • To keep up, lenders increase mortgage rates to ensure they get a good return on their money.

3. Bonds:

   • Mortgage rates often follow the yields of long-term government bonds, like the 10-year Treasury bond.
   • When bond yields go up, mortgage rates tend to rise as well.
   • Investors demand higher returns on bonds when they expect inflation or higher economic growth.

Putting It All Together:

• The FED rate influences how much it costs banks to get money.
• Inflation affects how much value that money will hold.
• Bond yields provide a benchmark for lenders to determine a competitive mortgage rate.

Simple Example:

Imagine you run a lemonade stand:

• If the cost of lemons (FED rate) goes up, you'll charge more per glass.
• If people expect lemons to cost more next month (inflation), you might raise prices now to prepare.
• If other stands (bonds) charge more, you'll also raise your prices to stay competitive.

So, mortgage rates are like your lemonade prices, influenced by the cost to make it, future expectations, and what others are charging!